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Title: The Theory of Optimum Currency Areas, Trade Adjustment and Trade

Author(s): Jacques Melitz

Publication Date: October 1993

Keyword(s): Exchange Rate Regime, International Trade, Optimum Currency Area and Trade Adjustment

Programme Area(s): International Macroeconomics

Abstract: This paper seeks to integrate more closely the theory of optimum currency areas with the theory of international trade. The currency area is considered as a continuous variable ranging from zero to one: zero if there is no enlargement, and some positive value otherwise, corresponding exactly to the percentage of trade in the enlarged area. The benefits of widening a currency area are then treated in the same way as a reduction in transportation costs. The costs of widening a currency area, in turn, are seen 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. This size depends heavily on the optimal composition of the members, however.

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Bibliographic Reference

Melitz, J. 1993. 'The Theory of Optimum Currency Areas, Trade Adjustment and Trade'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=847