Optimum Currency Area Theory


Optimum Currency Area Theory is a practice of using same exchange rate or same currency among a group of countries to ensure price stability and inflationary consequences in the region. The best example of OCA theory is the European Union. Under this practice, countries not only have to give up their domestic currencies but also have to maintain a flexible exchange rates regimes with the rest of the world as well. A currency area is a region within which circulates a single currency or in which exchange rates are fixed. A currency area is optimal, when fiscal and monetary policies are used efficiently to achieve the following objectives:

  • Full employment;
  • Balance of payments and balanced;
  • Average prices stabilized.

The theory of optimum currency areas is completely silent about the need for convergence in inflation rates, interest rates, and deficit debt. In contrast, emphasizes the need for flexibility in real wages, labor mobility, labor and fiscal integration and financial conditions as successful in creating a zone monetary integration. The theory of optimum currency areas states that there is no need for convergence “a priori” of inflation and interest rates and policies budget, as well as there is no need to fill this convergence to ensure successful integration. Why? For example, countries with different inflation rates before their entry into the integrated currency area may have economic structures quite similar, and were therefore advocated the relation to asymmetric shocks of great magnitude. The different inflation rates may only reflect different institutional positions in the face of monetary policy. Moreover, the convergence of inflation, prior to entry into the monetary integration was not enough. To develop the theory, it was unnecessary to fix the used concepts.


In the second half of the twentieth century, the process of regionalization was tougher, imposing greater challenges for economies increasingly needing mutual cooperation. In the mid-1980s, however, the main objective of monetary policy was modified to the pursuit of price stability. This amendment had a milestone at the end of the Bretton Woods System (1971), simultaneously with the increase of international prices caused by successive oil shocks. In 1961, Robert Mundell suggested the Optimum Currency Area theory with the help of which now countries like the ones in Europe had an option to to come together and adapt one single currency throughout the region to make sure the inflation and price stability can be controlled in the european union which is being practiced still today.


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