Exchange Rate For Euro: Just What is The Optimum Currency Area?

January 3rd, 2013

In economics an optimum currency area is defined as the ideal area, in population and size that a currency needs to provide the most efficiency when it comes to money exchange rates. A large amount of the rationale for the single European Currency was that an exchange rate for euro would be much better than the foreign currency exchange rates which were in existence as often these smaller currencies were far too small to operate with much impact. Robert Mundell and Abba Lerner are amongst the pioneers of the theory and the Single European currency is the most quoted example of a before and after study in Optimum Currency areas as it is the largest modern example of an attempt to create such a region.

In 1961 Mundell published a paper in which he discussed stationary expectations and criteria that must be fulfilled in order to be a successful currency in such a market. Amongst the most stated criteria include:-

1: Mobility and freedom of labour across the region. This includes the physical ability to do this and also the financial ability to do so.  With a solid exchange rate for euro currencies with nearby currencies such as the UK Pound and Danish Krone the mobility is certainly one criterion the Eurozone fulfils.

2: Openness in capital mobility. This means the automatic distribution of money to where it is needed in a supply and demand economy as the Eurozone is trying to be. Interestingly, since the single European currency has been introduced the reduction of foreign currency exchange between Eurozone countries has increased the amount of internal European trade in what is being called the Euro Effect.

3. A risk sharing system at the root of the optimum currency area is often cited as a hugely important factor but due to the nature of sovereignty in Europe this has become a point of contention in the Eurozone. Better of regions generally do not want to forsake the revenue they are able to achieve by gifting worse of nations. Perhaps an internal exchange rate for euro nations on the single currency would solve this? Though, being no different in practice than the prior system it would likely do more harm than good.

4. Similar financial and business cycles for countries within the optimum currency area. This means that all countries within the region are likely to undergo booms and busts at around the same time and can equally participate in foreign currency exchange through a centralised bank which operates and services the entire Eurozone.

We see the Eurozone as a great example of how you can attempt conversion of a financial region into an economic powerhouse. The United States is one other example. Check out the exchange rate for euro and other currencies with us at Best Exchange Rates UK.