Economics A-Z terms beginning with O | The Economist

Summary

A geographical area within which it would pay to have a single currency. An optimal currency area can come in many sizes. Some may span several countries and others may be smaller than an individual country. The benefits of having one currency are lower foreign exchange and currency HEDGING costs and more transparent pricing (because every PRICE is expressed in the same currency). But unless the single currency is used within an optimal currency area, these benefits may be dwarfed by the costs. A single currency means a single MONETARY POLICY and no opportunity for one part of the currency area to change its EXCHANGE RATE with the other parts. This can be a big problem if a country or region is likely to suffer from ASYMMETRIC SHOCKS that affect it differently from the rest of the single-currency area, because it will no longer be able to respond by loosening its national monetary policy or devaluing its currency. This may not be an insuperable problem if workers in the affected country are able and willing to move freely to other countries; if WAGES and prices are flexible and can adjust to the shock; or if FISCAL POLICY can shift resources to areas hurt by a shock from areas that are not hurt. For a currency area to be optimal, ideally asymmetric shocks should be rare, implying that the economies involved are on similar BUSINESS CYCLES and have similar structures. Moreover, the single monetary policy should affect all the constituent parts in the same way (an INTEREST RATE cut should not, say, reduce UNEMPLOYMENT in one part and increase INFLATION in another). There should be no cultural, linguistic or legal barriers to LABOUR mobility across frontiers; there should be wage flexibility; and there should be some system for transferring resources to regions that are suffering. In practice, few of the parts of the world that have a single currency are optimal currency areas, probably including the EURO ZONE, although having a single currency often makes them become gradually more alike and thus more optimal.

A geographical area within which it would pay to have a single currency. An optimal currency area can come in many sizes. Some may span several countries and others may be smaller than an individual country. The benefits of having one currency are lower foreign exchange and currency HEDGING costs and more transparent pricing (because every PRICE is expressed in the same currency). But unless the single currency is used within an optimal currency area, these benefits may be dwarfed by the costs. A single currency means a single MONETARY POLICY and no opportunity for one part of the currency area to change its EXCHANGE RATE with the other parts. This can be a big problem if a country or region is likely to suffer from ASYMMETRIC SHOCKS that affect it differently from the rest of the single-currency area, because it will no longer be able to respond by loosening its national monetary policy or devaluing its currency. This may not be an insuperable problem if workers in the affected country are able and willing to move freely to other countries; if WAGES and prices are flexible and can adjust to the shock; or if FISCAL POLICY can shift resources to areas hurt by a shock from areas that are not hurt. For a currency area to be optimal, ideally asymmetric shocks should be rare, implying that the economies involved are on similar BUSINESS CYCLES and have similar structures. Moreover, the single monetary policy should affect all the constituent parts in the same way (an INTEREST RATE cut should not, say, reduce UNEMPLOYMENT in one part and increase INFLATION in another). There should be no cultural, linguistic or legal barriers to LABOUR mobility across frontiers; there should be wage flexibility; and there should be some system for transferring resources to regions that are suffering. In practice, few of the parts of the world that have a single currency are optimal currency areas, probably including the EURO ZONE, although having a single currency often makes them become gradually more alike and thus more optimal.

Economics A-Z terms beginning with O | The Economist
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