Question

Describe the Theory of Optimal Currency Areas; and use that theory to consider whether the United States of America is an optimal currency area. Use statistical evidence to support your conclusion.

Answer 1

The optimum currency area means the geographical region which maximise the economic efficiency of that region with single currency. This will include the merger of currencies and formation of new currencies. In case of US, some regions do not fit an optimal currency with rest of the country. There are four major criteria for the successful currency union. They are, mobility of labour across the country, price and wage flexibility with free capital mobility, existence of automatic fiscal transfer and similar business cycle. The mobility of labour was one of the most important feature of US economy. So there is free mobility among the labours across the country. This mobility was mainly based on the physical ability to travel, reduction of cultural barriers for the movement and appropriate institutional arrangements. The fall in output and unemployment rate leads to the high rate of unemployment across the country. The supply and demand market forces automatically distribute the money and goods. This will not happen properly with there is rigid price.
An efficient risk sharing system can redistribute the money among the needy one. This can be used through the taxation redistribution in less developed countries. The countries with similar business cycle should follow this theory. This sharing can allows central bank to promote growth. In case of US Dollar this criteria’s are satisfied. So the dollar has high ability to influence the market conditions. So US currency is optimal in nature.