ABSTRACT
The article published by Robert Mundell in the American Economic Review in 1961 is one of the post-war masterpieces in international economics, and has been widely cited in the economics literature to date. 1 In the real-business cycle tradition (Pilkington, 2011a), Mundell argues that the economy is constantly bombarded by asymmetric shocks with the potential to undermine its performance. An introduction to the Optimal Currency Area (OCA) theory thus consists of a cost–benefit analysis of the adoption of a single currency, with, on the upside, lower transactions costs and the elimination of currency risks and, on the downside, the inability of states abandoning their currency to pursue independent monetary policies (Eichengreen, 1997, pp. 1–2). In a nutshell, the costs of the adhesion to a single currency area are the loss of monetary sovereignty with regard to monetary and exchange rate policy. Contrariwise, the benefits of a single currency area stem from the conditions, which need to be fulfilled, in order to mitigate the adverse effects of asymmetric shocks. Yet, it has been argued in this book that, although exchange rates matter in the NMC, as in the six-equation model presented in Chapter 3, the NMC does not feature any exchange rate commitment. Mundell (1968, p. 177) predicted that balance-of-payments crises would continue to afflict the world economy in the absence of floating exchange rates that help prices adjust between countries, thereby fulfilling a ‘natural role’ (ibid.). 2 Mundell characterized the pre-1971 era as an international disequilibrium system (ibid.), and was therefore a fierce opponent thereof. The roots of Mundell’s framework were clearly Keynesian, with a predominant role given to fine-tuning macroeconomic policy, understood as the adequate combination of monetary and fiscal policy, in order to manage aggregate demand and offset supply-side shocks (McKinnon, 2000). Yet, in 1968, he was unaware of the soon-to-come collapse of the Bretton Woods exchange rate system that would occur from 1971 onwards. With hindsight, his belief in the natural adjusting powers of the international price system was too optimistic in the light of the suboptimal outcomes experienced under the post-1971 floating exchange rate system wherein ‘the main currencies float and crush against each other like continental plates’ (Soros, 1997, p. 15). Yet, Mundell’s interrogations on future monetary arrangements, including the possibility of a single currency area, were already very relevant at the time: ‘supposing that the Common Market countries proceed with their plans for economic union, should these countries allow each national currency to fluctuate, or would a single currency area be preferable?’ (Mundell, 1961, p. 657). His reflection on exchange rates was rather healthy, and his foresight acute, because the rising forces of economic integration and disintegration had begun to shape the international economy in the 1960s: ‘[c]ertain parts of the world are undergoing processes of economic integration and disintegration, new experiments are being made, and a conception of what constitutes an optimum currency area can clarify the meaning of these experiments’ (ibid.).
