Optimal currency area In economics, an optimum currency area, or region (OCA or OCR), is a geographical region in which it would maximise economic efficiency to have the entire region share a single currency. There are two models, both proposed by
Robert Mundell: the
stationary expectations model and the
international risk sharing model. Mundell himself advocates the international risk sharing model and thus concludes in favour of the euro. However, even before the creation of the single currency, there were concerns over diverging economies. Before the
late-2000s recession it was considered unlikely that a state would leave the euro or the whole zone would collapse. However the
Greek government-debt crisis led to former
British Foreign Secretary Jack Straw claiming the eurozone could not last in its current form. Part of the problem seems to be the rules that were created when the euro was set up. John Lanchester, writing for
The New Yorker, explains it: Increasing business cycle divergence across the Eurozone over the last decades implies a decreasing optimum currency area.
Transaction costs and risks The most obvious benefit of adopting a single currency is to remove the cost of exchanging currency, theoretically allowing businesses and individuals to consummate previously unprofitable trades. For consumers, banks in the eurozone must charge the same for intra-member cross-border transactions as purely domestic transactions for electronic payments (e.g.,
credit cards,
debit cards and
cash machine withdrawals). Financial markets on the continent are expected to be far more
liquid and flexible than they were in the past. The reduction in cross-border transaction costs will allow larger banking firms to provide a wider array of banking services that can compete across and beyond the eurozone. However, although transaction costs were reduced, some studies have shown that
risk aversion has increased during the last 40 years in the Eurozone.
Price parity Another effect of the common European currency is that differences in prices—in particular in price levels—should decrease because of the
law of one price. Differences in prices can trigger
arbitrage, i.e.,
speculative trade in a
commodity across borders purely to exploit the price differential. Therefore, prices on commonly traded goods are likely to converge, causing inflation in some regions and deflation in others during the transition. Some evidence of this has been observed in specific eurozone markets.
Macroeconomic stability Before the introduction of the euro, some countries had successfully contained inflation, which was then seen as a major economic problem, by establishing largely independent central banks. One such bank was the
Bundesbank in Germany; the European Central Bank was modelled on the Bundesbank. The euro has come under criticism due to its regulation, lack of flexibility and rigidity towards sharing member states on issues such as nominal interest rates. Many national and corporate
bonds denominated in euro are significantly more liquid and have lower interest rates than was historically the case when denominated in national currencies. While increased liquidity may lower the
nominal interest rate on the bond, denominating the bond in a currency with low levels of inflation arguably plays a much larger role. A credible commitment to low levels of inflation and a stable debt reduces the risk that the value of the debt will be eroded by higher levels of inflation or default in the future, allowing debt to be issued at a lower nominal interest rate. There is also a cost in structurally keeping inflation lower than in the United States, United Kingdom, and China. The result is that seen from those countries, the euro has become expensive, making European products increasingly expensive for its largest importers; hence export from the eurozone becomes more difficult. In general, those in Europe who own large amounts of euro are served by high stability and low inflation. A
monetary union means states in that union lose the main mechanism of recovery of their international
competitiveness by weakening (
depreciating) their currency. When
wages become too high compared to
productivity in the exports sector, then these exports become more expensive and they are crowded out from the market within a country and abroad. This drives the fall of employment and output in the exports sector and fall of
trade and
current account balances. Fall of output and employment in the tradable goods sector may be offset by the growth of non-exports sectors, especially in
construction and
services. Increased purchases abroad and negative current account balances can be financed without a problem as long as
credit is cheap. The need to finance trade deficit weakens currency, making exports automatically more attractive in a country and abroad. A state in a monetary union cannot use weakening of currency to recover its international competitiveness. To achieve this a state has to reduce prices, including wages (
deflation). This could result in high
unemployment and lower incomes as it was during the
euro area crisis.
Trade The euro increased price transparency and stimulated cross-border trade. A 2009 consensus from the studies of the introduction of the euro concluded that it has increased trade within the eurozone by 5% to 10%, and a
meta-analysis of all available studies on the effect of introduction of the euro on increased trade suggests that the prevalence of positive estimates is caused by
publication bias and that the underlying effect may be negligible. Although a more recent meta-analysis shows that publication bias decreases over time and that there are positive trade effects from the introduction of the euro, as long as results from before 2010 are taken into account. This may be because of the inclusion of the
2008 financial crisis and ongoing integration within the EU. Furthermore, older studies based on certain methods of analysis of main trends reflecting general cohesion policies in Europe that started before, and continue after implementing the common currency find no effect on trade. These results suggest that other policies aimed at European integration might be the source of observed increase in trade. According to Barry Eichengreen, studies disagree on the magnitude of the effect of the euro on trade, but they agree that it did have an effect. Regarding foreign direct investment, a study found that the intra-eurozone FDI stocks have increased by about 20% during the first four years of the EMU. Concerning the effect on corporate investment, there is evidence that the introduction of the euro has resulted in an increase in investment rates and that it has made it easier for firms to access financing in Europe. The euro has most specifically stimulated investment in companies that come from countries that previously had weak currencies. A study found that the introduction of the euro accounts for 22% of the investment rate after 1998 in countries that previously had a weak currency.
Inflation The introduction of the euro has led to extensive discussion about its possible effect on inflation. In the short term, there was a widespread impression in the population of the eurozone that the introduction of the euro had led to an increase in prices, but this impression was not confirmed by general indices of inflation and other studies. A study of this paradox found that this was due to an asymmetric effect of the introduction of the euro on prices: while it had no effect on most goods, it had an effect on cheap goods which have seen their price round up after the introduction of the euro. The study found that consumers based their beliefs on inflation of those cheap goods which are frequently purchased. It has also been suggested that the jump in small prices may be because prior to the introduction, retailers made fewer upward adjustments and waited for the introduction of the euro to do so. Based on the
introduction of the euro as the official currency in Croatia in 2023, the ECB argues that inflation due to a change of currency is a one-time effect of limited impact.
Exchange rate risk One of the advantages of the adoption of a common currency is the reduction of the risk associated with changes in currency exchange rates. These reductions in market risk "were concentrated in firms domiciled in the eurozone and in non-euro firms with a high fraction of foreign sales or assets in Europe".
Financial integration The introduction of the euro increased financial integration within Europe, which helped stimulate growth of a European
securities market (bond markets are characterized by
economies of scale dynamics). Specifically, the euro has significantly decreased the cost of trade in bonds, equity, and banking assets within the eurozone. On a global level, there is evidence that the introduction of the euro has led to an integration in terms of investment in bond portfolios, with eurozone countries lending and borrowing more between each other than with other countries. Financial integration made it cheaper for European companies to borrow. Following the
2008 financial crisis, governments in these countries found it necessary to bail out or nationalise their privately held banks to prevent systemic failure of the banking system when underlying hard or financial asset values were found to be grossly inflated and sometimes so nearly worthless there was no liquid market for them. This further increased the already high levels of public debt to a level the markets began to consider unsustainable, via increasing government bond interest rates, leading to the
euro area crisis.
Price convergence The evidence on the convergence of prices in the eurozone with the introduction of the euro is mixed. Several studies failed to find any evidence of convergence following the introduction of the euro after a phase of convergence in the early 1990s. Other studies have found evidence of price convergence, in particular for cars. A possible reason for the divergence between the different studies is that the processes of convergence may not have been linear, slowing down substantially between 2000 and 2003, and resurfacing after 2003 as suggested by a recent study (2009).
Tourism A study suggests that the introduction of the euro has had a positive effect on the amount of tourist travel within the EMU, with an increase of 6.5%. == Exchange rates ==