Economics, 3rd Edition

IS EUROPE AN OPTIMUM CURRENCY AREA?

Having determined what characteristics of a group of countries would make the benefits of a single 

 currency stronger and the costs weaker, we can take a closer look to see whether Europe – and in 

 particular the group of 18 countries that comprise the euro area – forms an optimum currency area.

Trade Integration

The degree of trade integration can be assessed by looking at imports from and exports to other EU 

 countries expressed as a percentage of GDP. The degree of trade integration across Europe is quite 

variable, but nevertheless on average quite high – with the notable exception of Greece. The degree of 

European trade integration has been rising over time, in nearly every country in the EU but the integration 

has been more marked in some countries such as Austria than others such as the UK and Italy.

This has led some economists to argue that some of the criteria for an optimum currency area – such 

as a high degree of trade integration – may actually be endogenous: actually being a member of a currency 

union may enhance the degree of trade done between members of the union, precisely because of the 

decline in transaction costs in carrying out such trade.

Overall many – if not all – European countries have gained a great deal from the reduction in transaction 

costs in international trade as a result of the single currency. Indeed, these gains have been estimated 

at about one quarter to one half of one per  cent of euro area GDP. This may not sound massive, but 

 remember that transaction costs are a deadweight loss. Moreover, the gains are not one-off: they accrue 

continuously as long as the single currency persists, since they would have to be paid in the absence 

of the currency union. They therefore become cumulative. In addition, if the degree of euro area trade 

 integration tends to rise over time as a result of the single currency, as some economists have suggested, 

then the implicit gain from not having to pay transaction costs also rises over time.

The other, indirect benefit of a single currency when there is a high degree of trade integration, follows 

from the reduction in uncertainty associated with doing away  with the volatility in the exchange rates 

between members’ national currencies (since those currencies are replaced with a common currency). 

These gains are hard to quantify, but it is not incorrect to suggest that they are not negligible for the 

euro area.