Is Europe an optimum currency area?∗

Guglielmo Maria Caporale

National Institute Economic Review, 1993, vol. 144, 95-113

Abstract: Much of the debate on the desirability of a monetary union in Europe has focused on the question of whether Europe can be described as an optimum currency area (OCA). The European Commission in its report ‘One money, one market’ takes the view that this theoretical framework gives useful insights for the analysis of the economics of EMU and its potential costs and benefits, even though it is not decisive, but it has to be complemented by other approaches. Many studies have tried to provide an answer to the topical question of the optimality of introducing a single currency, adopting different research strategies. This note explains why a knowledge of the nature of the shocks is crucial to evaluating the potential costs of creating a monetary union, and applies a statistical technique known as principal components analysis to distinguish between common and country-specific shocks. After surveying the existing literature on OCAs, we present some new empirical results which confirm the relative importance of asymmetric shocks in the Community. A well-functioning monetary union could require some instruments for adjusting to shocks of this kind, for example fiscal transfers across the member countries.

Date: 1993
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