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AN OPTIMUM-CURRENCY-AREA ODYSSEY

Harris Dellas
University of Bern

George S. Tavlas
Bank of Greece



Abstract
The theory of optimum-currency-areas was conceived and developed in three highly influential papers, written by Mundell (1961), McKinnon (1963) and Kenen (1969). Those authors identified characteristics that potential members of a monetary union should ideally possess in order to make it feasible to surrender a nationally- tailored monetary policy and the adjustment of an exchange rate of a national currency. We trace the development of optimum currency- area theory, which, after a flurry of research into the subject in the 1960s, was relegated to intellectual purgatory for about 20 years. We then discuss factors that led to a renewed interest into the subject, beginning in the early 1990s. Milton Friedman plays a pivotal role in our narrative; Friedman’s work on monetary integration in the early 1950s presaged subsequent optimum-currency-area contributions; Mundell’s classic formulation of an optimal currency area was aimed, in part, at refuting Friedman’s ‘‘strong’’ case for floating exchange rates; and Friedman’s work on the role of monetary policy had the effect of helping to revive interest in optimum-currency-area analysis. The paper concludes with a discussion of recent analytical work, using New Keynesian models, which has the promise of fulfilling the unfinished agenda set-out by the original contributors to the optimum-currency-area literature, that is, providing a consistent framework in which a country’s characteristics can be used to determine its optimal exchange-rate regime.


Keywords: Optimum-currency-areas, Exchange-rate regimes, New Keynesian models
JEL classifications: F33, F41

Acknowledgments: We have benefited from helpful comments on an earlier draft from Russell Boyer, Filippo Cesarano, W. Max Corden, John Devereux, Jerry Dwyer, Heather Gibson, Peter Kenen, James R. Lothian, Ronald McKinnon, Francesco Mongelli, Michael Ulan. We are also grateful to participants in the Federal Reserve Bank of Atlanta/Fordham University Conference, ‘‘Money and Monetary Policy’’, for comments and to Warren Young for providing us with Milton Friedman’s personal correspondence during the early 1950s. The views expressed are those of the authors and should not be interpreted as those of their respective institutions.


Correspondence:

George S. Tavlas
Bank of Greece, 21, El. Venizelou Ave.,
10250 Athens, Greece,
Tel. +30210-3202370
Fax +30210-3202432
e-mail: gtavlas@bankofgreece.gr

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