The Case for Monetary Union Reexamined with the Benefit of the Single Monetary Policy

Abstract

A traditional OCA criterion holds that the more symmetric the shock exposure of countries, the more suited they are for currency union. According to Frankel and Rose (1998, 2002), growing correlation of the ex post income fluctuations of members also can provide endogenous justification for regional monetary union (MU) after its creation. Trade-enhancing effects of MU increase symmetry of shock exposure. But the single monetary policy of a multilateral MU in theory counteracts net disturbances to the union as a whole to the extent consistent with low inflation. This would leave mostly idiosyncratic disturbances and hence less symmetry among the national disturbance effects that remain. But recent evidence from the euro area yields results contrary to those expected.

Keywords: Monetary Union, Monetary Policy, Optimum Currency Area (OCA)

JEL Classification: F33, F36, F41