Economics, 3rd Edition

Summary: So is Europe an Optimum Currency Area?

As in many policy debates in economics, there is no clear-cut answer to this question. Certainly, many 

European countries have a high degree of intra-union trade and have economic cycles that are more or less 

synchronized. However, labour mobility and wage flexibility (and labour market flexibility in general) are 

low in Europe, and while the euro has increased financial market integration in the euro area’s wholesale 

financial markets, the retail markets remain highly segregated at the national level.

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772  PART 15  INTERNATIONAL MACROECONOMICS

Overall, therefore, if very strong differences in the economic cycle were to emerge across the euro 

area, the lack of independent monetary and exchange rate policy would be acutely felt. This could 

be a case argued in relation to the situations in Ireland and Greece as highlighted in Figure 36.4. 

For that reason, many economists argue that Europe – meaning the current euro area – is not an 

optimum  currency area. Nevertheless, as we have noted in our discussion, it is possible that some of 

the optimum currency area criteria may be endogenous. In particular, the single currency is likely to 

generate even greater trade among EMU members. Given this, it is likely that the economic cycles of 

member  currencies will become even more closely synchronized as aggregate demand shifts in one 

country have stronger and stronger spillover effects in other euro area countries; this may, however, 

take some time to synchronize and the problems the EU has faced since the financial crisis have 

exposed the differences in the relative strength of the economies of the countries, in the euro area in 

particular, which has pushed EMU to its limits.

Over time, the single currency, if it survives, may also raise labour mobility across Europe in the long 

run, since being paid in the same currency as in one’s home country is one less issue to come to terms 

with when moving location to find a job. Also, with time, one would expect financial market integration to 

spread to the retail capital markets (indeed there is already strong pressure being exerted on the European 

banking industry by the European Central Bank and the European Commission for the introduction of new 

payment schemes for electronic credit transfers and direct debits between euro area banks, as well as for 

a unified framework for debit and credit cards).

Perhaps the only true test of whether the euro area is an optimum currency area (or can become 

one) is to see whether EMU survives in the long run. The challenges faced by the euro area since the 

 financial crisis have put the long-term survival of the whole euro project in doubt. Significant changes to 

the  structure of the euro, in particular financial regulation and fiscal reform, are the subject of on-going 

discussion and fiscal policy is the subject of our next section.