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Columbia Economist and Nobel Laureate Robert Mundell is considered to be the intellectual “father of the euro” for his pioneering work on common currency areas. His seminal 1961 paper “A Theory of Optimum Currency Areas“ lays out a blueprint for a regional currency union.However, if the writers of the Maastricht Treaty used Mundell as their inspiration, they didn’t read carefully enough.
More than 40 years ago, he explained exactly why the euro crisis would happen: “it is not feasible” to have a currency union where there are no fiscal transfers because the union will be unstable.
Major points from the paper:
- The optimum currency area is a region, an area with similar economies and labour markets.
- A region is defined by internal factor mobility, and factor immobility outside.
- Fiscal union and a lessening of national sovereignty is necessary to prevent imbalances.
- If there is insufficient mobility of capital and labour, persistent imbalances will occur because currency revaluation won’t perform its usual stabilisation function.
- Particularly relevant to today’s ECB is his claim that “the pace of inflation is set by the willingness of central authorities to allow unemployment in deficit regions.
From the paper:
Except in areas where national sovereignty is being given up it is not feasible to suggest that currencies should be re-organised; the validity of the argument for flexible exchange rates therefore hinges on the closeness with which nations correspond to regions. The argument works best if each nation (and currency) has internal factor mobility and external factor immobility. But if labour and capital are insufficiently mobile within a country then flexibility of the external price of the national currency cannot be expected to perform the stabilisation function attributed to it, and one could expect varying rates of unemployment or inflation in the different regions.
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