Crisis in the Eurozone: Analyzing the EMU under the Framework of Optimum Currency Area Theories
Date
2014-05-21
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Abstract
In 1961, Robert Mundell pioneered the Theory of Optimum Currency Areas (OCA), which outlined a set of criteria that would allow a geographical region, often exceeding national boundaries, to maximize economic efficiency by adopting a single currency. Since Mundell, numerous authors have contributed additional criteria for effective currency unions, resulting in a collection of OCA Theories. In the 1990s, these theories provided considerable support to the formation of the European Economic and Monetary Union (EMU). However, the recent European sovereign debt crisis has highlighted several critical weaknesses of the Eurozone and a persistent failure to comply with supranational regulations. Ex post research has revealed that, at conception, the Eurozone member states did not meet the proposed criteria for OCAs. Rather, political, social and institutional considerations were highly instrumental in driving the European monetary experiment.
This thesis argues that the roots of the existing imbalances in the Eurozone were primarily caused by the misguided political optimism and overdependence on the Endogeneity Hypothesis of OCAs, which led to the formation of a suboptimal monetary union. We present a discussion of recent measures undertaken by the European Central Bank (ECB) to bail out distressed EMU members and the ramifications of these programs. Through tracing member states’ fiscal indiscipline and the failure of the Stability and Growth Pact, this thesis seeks to demonstrate that the Eurozone cannot be expected to function as a true currency union while it lacks an effective, supranational fiscal authority to complement the ECB.
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Keywords
Eurozone, Currency Union, Crisis