Have you ever thought of why some regions have their own currencies? why they don’t use the single currency for their purpose? Take a thought that, what if the whole world has the global currency! Yes, One World One Currency!
Let’s discuss the Optimum currency area theory which is the same as the thought that we take one moment earlier.
The idea of Optimum currency area theory was proposed by well-known Canadian economist Robert Mundell in 1961. He received the Nobel Memorial Prize in Economic Sciences in 1999 for his pioneering work in monetary dynamics and optimum currency areas. He is known as the father of the Euro.
What this theory proposes?
Basically, Optimum currency area is the idea of the global currency means specific areas will use the same currency and they will not be bounded by any national boundaries so all benefits will be received by the single currency. Mundell defines the absence of exchange rate mechanism as the cost of monetary union.
Monetary union is a currency union of two or more regions which shares the same currency. One primary goal of forming a currency union is to synchronize their exchange rate.
The member countries of the currency area do not need to bring any changes while bringing integration among them.
In the currency area, open economies which are part of this theory will get linked through permanently fixed exchange rates.
What are the Benefits OCA theory?
In this theory, the entities are regions within a closed economy lubricated by a common currency. So it eliminates the flexible exchange rate between those entities. So the stability between the exchange rate will lead to stability in prices of the member countries.
This will allows a large group of workers a large market and they can move out if there is unemployment in any single zone.
The regions in the currency area will have a similar business cycle and proper balance between economic affairs to avoid any shock in one area.
Formation of an optimum currency area saves the formation and intervention cost of the foreign exchange market.
Another benefit will be such as lower interest rate, lower inflation rate and there will be increased trade between the currency areas.
Disadvantages of OCA theory
If some countries adopt the single currency then there will be loss of the monetary policy.
Monetary policy is a process by which the authority of a certain country decides their interest rate and financial decisions for proper stability of price.
There is another issue for currency area that countries may face asymmetric shock due to the different economic cycle and it may affect other countries.