The theory of optimum currency areas, trade adjustment, and trade

Jacques Melitz

Open Economies Review, 1996, vol. 7, issue 2, 99-116

Abstract: This article seeks to provide a closer integration of the theory of optimum currency areas with the theory of international trade. A currency area is treated as a continuous variable ranging from zero to one: zero if there is no enlargement, and some positive value otherwise, corresponding exactly to the percentge of trade in the enlarged area. The benefits of widening a currency area are then regarded, in terms of conventional trade theory, as equivalent to a reduction in transportation cost. The costs of widening a currency area are seen, instead, with reference to open economy macroeconomics, as a drop in the speed of adjustment of the terms of trade to their long-run equilibrium level. On this basis, it is shown that the marginal benefits of enlarging a currency area fall, the marginal costs rise, and an optimum size arises. But this size depends heavily on the optimal composition of the members. Copyright Kluwer Academic Publishers 1996

Keywords: optimum currency areas; exchange rate regime; trade adjustment; international trade (search for similar items in EconPapers)
Date: 1996
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Working Paper: The Theory of Optimum Currency Areas, Trade Adjustment and Trade (1993)
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DOI: 10.1007/BF01891898

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