When Is Monetary Union Desirable?

According to Optimal Currency Area Theory, a range of criteria exists intended to determine the conditions under which monetary union is desirable and highly likely to have a positive effect. The theory was established by Canadian economist Robert Mundell, who published his reflections in this regard in 1961. He proposed four major indicators for an optimal currency area. The first one is “high labor mobility throughout the area.” This criterion involves lowering administrative, cultural, and institutional barriers to a large extent. Secondly, “capital mobility and price and wage flexibility” is also a crucial issue. The third indicator implies risk sharing in the context of transferring money. Apart from this option, it can be substituted by a fiscal mechanism, which is aimed at sharing the risks among countries. The last one regards the requirement on a similarity of business cycles in the countries.

In addition, it should be noted that later economic research advanced three more conditions. For instance, “a high volume of trade between countries” is also an important aspect, as the benefits of the currency union would be obviously considerable. Moreover, the aforementioned union is associated with the diversity of production, limited specialization, and division of labor. These factors lead to minimizing asymmetric economic shocks. Finally, “monetary policy, and to some extent, fiscal policy in the form of transfers, will be a collective decision and responsibility of the countries in the OCA.” Therefore, it is vital to have particular similarities between countries and connections in the field of economics and to achieve an appropriate level of development.