Lecture 5Costs of Single Currency

OCA TheoryCool Example

Less transactions costs

More price transparency

Less uncertainty

More economic growth

Last Week

With Neal

Costs of EMULoss of Flexibility

Asymmetric Effects

Costs of a Single Currency

PO PC

YOYC

DO

SO

DC

SC

Effectiveness of devaluation as a function of openness

Very open country Relatively closed country

UG

Can Ireland reach a more attractive (lower) inflation equilibrium?

UI

Germany Ireland

A

E

C

G

F

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