Lecture 5
Costs of Single Currency
OCA Theory
Cool Example

Last Week
Less transactions costs
More price transparency
Less uncertainty
More economic growth

With Neal
Costs of EMU
Loss of Flexibility
Asymmetric Effects

Costs of a Single
Currency

Effectiveness of devaluation as a function of
openness
Very open country Relatively closed country
PO PC
SO
SC
DO
DC
YC
YO

Can Ireland reach a more attractive
(lower) inflation equilibrium?
Germany Ireland
E
G
C F
A
UG UI
Fixing the exchange rate of the Punt with the Dmark is not credible, because Irish
authorities have an incentive to create surprise inflation (devaluation)

Optimal Currency
Area Theory

“An optimum currency
area is a group of
countries for whom
it is optimal to adopt
a common currency
and form a currency
union.”
See http://faculty.haas.berkeley.edu/arose/ABTFinalNBER.pdf

1. Labour Mobility
2. Production Diversification
3. Openness
4. Fiscal Transfers
5. Homogeneous Preferences
6. Commonality of Destiny

Handout

Cool
Example