Optimum currency area


The group of countries that maximizes the benefits of using a single currency. The gain from extending a currency area is the reduction in transaction costs in respect of trade and financial transactions between members, and the reduction in currency risk affecting such transactions. This is greater the larger such transactions are relative to national incomes. The loss is that if the countries are affected by asymmetric shocks, have different preferences about any trade-off between stable prices and stable real output, having a single currency removes changes in the exchange rate between them as a possible equilibrating mechanism. For any given level of transaction costs, the net advantage of a single currency is larger the more similar the areas are in their preferences and the shocks they are expected to sustain, and is smaller the more their preferences and expected shocks differ. The desirability of a single curreny also depends on the effectiveness of the other available means of adjustment. The more prices are flexible and factors of production are mobile, the less the need for exchange rate adjustments, so the greater the net benefits of a single currency.


Reference: Oxford Press Dictonary of Economics, 5th edt.