Theory of Optimum Currency Areas

Abstract

This article aims at providing an eclectic analysis of the theory of optimum currency areas (OCAs). Although the basic tenets of the theory were anticipated during the late 1940s and the 1950s, the theory was developed and maturated in three highly influential papers of Mundell (1961), McKinnon (1963) and Kenen (1969). However, because of internal conflicts and contradictions, the theory gathered gloom for the next two decades before it could make a solid comeback in the early 1990s. Much of the reason of this revival was the efforts towards the reconciliation of these internal conflicts. During this period, the theory moved beyond the usual cost–benefit analysis and reflected a shift from the criteria that emphasise on the state of the economy towards the criteria that focus on desired policy trade-offs. Recent advancements in the area using dynamic general equilibrium analysis shows that the revival of interest in the theory of OCA reflects developments in a literature that has little to do with the subject of OCAs itself. The merit of the OCA theory is that it helps to bring together several strands of the literature on monetary integration.