10. United States v. E. 1. duPont de Nemours and Co., 351 U.S. 377 (1956). 11. United States v. E. I. duPont de Nemours and Co., 353 U.S. 586 (1957). 12. U. S. Senate Report No. 1775, 81st Cong., 2d Sess., 1950. Amending Act to Supplement Existing Laws Against Unlawful Restraints and Monopolies.
A Theory of Optimum Currency Areas
It is patently obvious that periodicbalance-of-payments crises will remain an integral feature of the international economic system as long as fixed exchange rates and rigid wage and price levels prevent the terms of trade from fulfilling a natural role in the adjustment process. It is, however, far easier to pose the problem and to criticize the alternatives than it is to offer constructive and feasible suggestions for theelimination of what has become an international disequilibrium system.' The present paper, unfortunately, illustrates that proposition by cautioning against the practicability, in certain cases, of the most plausible alternative: a system of national currenciesconnected by flexible exchange rates. A system of flexible exchange rates is usually presented, by its proponents,2 as a device whereby depreciationcan take the place of unemployment when the external balance is in deficit, and appreciation can replace inflation when it is in surplus. But the question then arises whether all existing national currencies should be flexible. Should the Ghanian pound be freed to fluctuate against all currenciesor ought the present sterling-areacurrenciesremain pegged to the pound sterling? Or, supposing thatthe Common Market countries proceed with their plans for economic union, should these countries allow each national currency to fluctuate, or would a single currency area be preferable? The problem can be posed in a general and more revealing way by defining a currency area as a domain within which exchange rates are fixed and asking: What is the appropriatedomain of a currency area? It might seemat first that the question is purely academic since it hardly appears within the realm of political feasibility that national currencies would ever be abandoned in favor of any other arrangement.To this, three answers can be given: (1) Certain parts of the world are undergoingprocesses of economic integration and disintegration, new experiments are being made, and a conception of what constitutesan optimum currency area can clarify the meaning of these experiments. (2) Those countries, like Canada, which have experimented with flexible exchange rates are likely to face particular problems which the theory of optimumcurrency areas can elucidate if the national currencyarea does not coincide with the optimum currency area. (3) The idea can be used to illustrate certain functions ofcurrencieswhich have been inadequately treated in the economic literature and which are sometimes neglected in the consideration of problemsof economicpolicy.
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THE AMERICANECONOMIC REVIEW
I. CurrencyAreas and Common Currencies A single currency implies a single central bank (with note-issuing powers) and thereforea potentially elastic supply of interregionalmeans of payments. But in a currency area comprisingmore than one currency the supply of international means of payment is conditional upon the cooperation of many central banks; no central bank can expand its own liabilities much faster than other central banks without losing reserves and impairingconvertibility.3This means that there will be a majordifferencebetween adjustment within a currency area which has a single currencyand a currencyarea involving more than one currency; in other words there will be a differencebetween interregional adjustment and international adjustment even though exchange rates, in the latter case, are fixed. To illustrate this differenceconsider a simple model of two entities (regions or countries), initially in...