Abstract

Optimal Currency Areas: A Sourvey of the Literature

The article provides an introduction to the theoretical concept of optimal currency areas and deals with its development and the criticism devoted to it. The first part deals thoroughly with the basic treatises by Mundell, McKinnon and Kenen. It emphasizes the fact that the approaches of the first two of these authors do not, strictly speaking, have a common denominator, but represent two mutually complementary criteria and treat the problem of how far an optimal currency area should extend from two different angles, Mundell concentrating on the real and McKinnon on the monetary aspect of the economy. Kenen’s contribution submits a third criterion, the diversification of an economy, for debate. In the second part of the article, various, further developments are discussed: Fleming’s attempt to determine the advantages and disadvantages of a currency union as compared with a system of currencies with adjustable pegs, Sohmen’s emphasis on convertibility of a currency as against unilateral treatment of exchange rate fluctuations in various currency systems, and lastly, Aliber’s approach, which systematically introduces uncertainty considerations into the analysis and arrives at a trade-off between greater efficiency of fixed exchange rates and greater independence of monetary policy with flexible rates. The welfare-theoretical contributions of Jerome Stein, Lanyi, Grubel and De Cecco lie on a different plane; especially Lanyi’s analysis is discussed thoroughly. The article closes with a ventilation of some recent contributions by Laffer and Mundell, who marshal arguments for fixed exchange rates, and of the criticism levelled by Balassa and Haberler. As the upshot of this theoretical development it can be said that the future fruitfulness of the conception of an optimal currency area will probably be limited. As Swoboda remarks, the issue in the future will be the definition of viable currency areas. However, the debate on the optimal currency area has led to differentiated analyses and given rise to some results which have differentiated the simple question “fixed or floating exchange rates” and adapted it more closely to the needs of practical monetary policy.