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Revenge of the optimum currency area

Author(s): Krugman, Paul R.

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Abstract: The creation of the euro was supposed to be another triumphant step in the European project, in which economic integration has been used to foster political integration and peace; a common currency, so the thinking went, would bind the continent even more closely together. What has happened instead, however, is a nightmare: the euro has become an economic trap, and Europe a nest of squabbling nations. Even the continent’s democratic achievements seem under threat, as dire economic conditions create a favorable environment for political extremism. Who could have seen such a thing coming? Well, the answer is that lots of economists could and should have seen it coming, and some did. For we have a long-established way to think about the prospects for currency unions, the theory of optimum currency areas—and right from the beginning, this theory suggested serious concerns about the euro project. These concerns were largely dismissed at the time, with many assertions that the theory was wrong, irrelevant, or that any concerns it raised could be addressed with reforms. Recent events have, however, very much followed the lines one might have expected given good oldfashioned optimum currency area theory, even as they have suggested both that we need to expand the theory and that some aspects of the theory are more important than we previously realized. In what follows, I’ll start with a very brief and selective review of what I consider the key points of optimum currency area theory, and what that theory seemed, some two decades ago, to say about the idea of a single European currency. Next up is the crisis, and the continuing refusal of many leaders to see it for what it is. Finally, some thoughts on possible futures.
Publication Date: 2012
Citation: Krugman, P. (2012). Revenge of the optimum currency area. NBER Macroeconomics Annual, 27 (1), 439 - 448. doi:10.1086/669188
DOI: doi:10.1086/669188
ISSN: 0889-3365
Pages: 439 - 448
Type of Material: Journal Article
Journal/Proceeding Title: NBER Macroeconomics Annual
Version: Final published version. Article is made available in OAR by the publisher's permission or policy.

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