Rethinking Optimal Currency Areas

Patrick Kehoe, Alessandro Dovis and Varadarajan Chari
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Alessandro Dovis: Penn State

No 826, 2014 Meeting Papers from Society for Economic Dynamics

Abstract: The classic optimal currency area criterion is that countries with more correlated shocks are better candidates to form a union. We show that when countries have credibility problems this simple criterion must be changed: Symmetric countries gain credibility when joining the union only when the shocks affecting credibility are not highly correlated. Our analysis provides a amended optimal currency area criterion that we argue is more relevant than the classic one. We illustrate our argument both for a reduced form model and for a relatively standard sticky-price general equilibrium model. We argue that our new criterion should lead to a rethinking of the massive amount of empirical work on optimal currency areas.

Date: 2014
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Journal Article: Rethinking Optimal Currency Areas (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed014:826

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