Are central european countries part of the European Optimum Currency Area?

De Grauwe, P.C. and Aksoy, Yunus (1999) Are central european countries part of the European Optimum Currency Area? In: De Grauwe, P.C. and Lavrac, V. (eds.) Inclusion of Central European Countries in the European Monetary Union. Boston, U.S., pp. 13-36. ISBN 9780792383857.

Abstract

The theory of optimum currency areas (OCA) has analysed the conditions that countries should satisfy if they want to profit from joining a monetary union. The main insights of the theory can be summarised as follows. When countries are different in economic structures, they are likely to face ‘asymmetric shocks’. In the absence of the exchange rate instrument, they will need a lot of flexibility in their labour markets (e.g. wage flexibility, labour mobility) so as to adjust to these asymmetric shocks and to prevent these shocks from leading to permanent unemployment. The OCA-theory also stresses that the cost of relinquishing the exchange rate instrument declines with the openness of the country. For very open countries the exchange rate instrument loses much of its effectiveness to affect output and employment, and therefore to correct for asymmetric shocks. Thus, very open (and typically small) countries bear fewer costs by joining a monetary union than large and relatively closed economies. Conversely, the benefits of a single currency increase with the degree of openness of a country, because more contracts involve exchange rate transactions in small open economies than in large and relatively closed ones.

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