Download Zuzana Kucerova

„The OCA Theory and its
Application to Central and
Eastern European Countries“
Zuzana Kucerova
Technical University of Ostrava
Faculty of Economics
Contents
1. Introduction
2. The OCA Theory and its Criteria
3. The Cost and Benefits of Fixed
Exchange Rates
4. The Endogeneity of the OCA Criteria
5. Eastern EMU Enlargement in the
context of the OCA Theory
6. Conclusions
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The OCA Criteria
• R. A. Mundell (1961)
The factor mobility
• R. I. McKinnon (1963)
The degree of economic openness
• P. B. Kenen (1969)
The diversification of production and
consumption
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R. A. Mundell (1961, p. 663)
„If factor mobility is high internally and low
internationally, a system of flexible
exchange rates based on national currencies
might work effectively enough. But if
regions cut across national boundaries or if
countries are multiregional, then the
argument for feasible exchange rates is only
valid if currencies are reorganized on a
regional basis.“
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R. I. McKinnon (1963, p. 719)
„If we move across the spectrum from closed to
open economies, flexible exchange rates
become both less effective as a control device
for external balance and more damaging to
internal price level stability. In fact, if one were
worried about unwanted speculative
movements in a floating exchange rate in case
of an open economy, a policy of completely
fixed exchange rate would be optimal.“
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P. B. Kenen (1969, p. 54)
„Fixed rates … are most appropriate – or least
inappropriate – to well-diversified national
economies. Ex ante, diversification serves to
average out external shocks and, incidentally,
to stabilize domestic capital formation. Ex
post, it serves to minimize the damage done
when averaging is incomplete.“
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Other OCA Criteria
• Price and wage flexibility
• Similarity of supply and demand shocks
• Fiscal transfers
• Financial market integration
• Similarity of inflation rates
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The Costs and Benefits of Fixed
Exchange Rates
The GG-LL Model
Gains and losses from
joining a currency area
GG
1
LL
A
Degree of economic
integration
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The Endogeneity of the OCA
Criteria
„… a naive examination of historical data
gives a misleading picture of a country’s
suitability for entry into a currency union,
since the OCA criteria are endogenous.“
Frankel and Rose (1998)
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The OCA Line
Correlation of business
cycles
Good candidates
for a common
currency
Countries that
should float
independently
OCA line
Degree of economic
integration
10
The Endogeneity Hypothesis
Conventional View of an OCA
Gains and losses from
joining a currency area
L
The Endogeneity Hypothesis
Correlation of
business cycles
G
3
2
1
G
L
Degree of economic
integration
OCA line
EU EMU
Degree of economic
integration
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The Specialisation Hypothesis
Alternative View of an OCA
Gains and losses from
joining a currency area
The Specialisation Hypothesis
Correlation of
business cycles
G
L
L
1
EMU 2
G
Degree of economic
integration
OCA line
Degree of economic
integration
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Eastern EMU Enlargement in the
Context of the OCA Theory
Some possible approaches:
1. Correlation of supply and demand
shocks
2. Correlation of business cycles
3. Convergence of monetary policies
4. The OCA index
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1. Correlation of Supply and
Demand shocks
• SVAR models of output growth and inflation
• Bayoumi – Eichengreen (1993)  Does EMU
constitute an OCA?
• Frenkel et al. (1999), Horvath (2002) 
correlation between CEECs and Germany or
France
• Fidrmuc – Korhonen (2001), Weimann (2002) 
correlation between CEECs and Eurozone
• Babetski et al. (2002)  correlation between
CEECs and Germany or EU-15
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2. Correlation of Business Cycles
• Boone – Maurel (1998), (1999) 
correlation between CEECs and Germany
or EU-15
• Korhonen (2001)  correlation between
CEECs and Eurozone
• Fidrmuc (2001)  correlation between
CEECs and Germany, intra-industry trade
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3. Convergence of Monetary
Policy
• Nominal convergence
• Brada – Kutan (2001)  convergence of
base money between CEECs and Germany,
a cointegration method
• Brada et al. (2002)  convergence of base
money, M2, CPI and industrial output
between CEECs and Germany or France,
a rolling cointegration method
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4. OCA index
• Structural convergence
• Bayoumi – Eichengreen (1997) – authors of the
OCA index
SD (eij) = β0 + β1 SD(Yi – Yj) + β2 DISSIMij + β3 TRADEij +
β4 SIZEij
SD (eij) is the standard deviation of the change in the logarithm of the
end-year bilateral exchange rate between countries i and j;
SD(Yi – Yj) is the standard deviation of the difference in the logarithm of
real output between i and j;
DISSIMij is the sum of the absolute differences in the shares of
agricultural, mineral, and manufacturing trade in total trade;
TRADEij is the mean of the ratio of bilateral exports to domestic GDP for
countries i and j;
SIZEij is the mean of the logarithm of the two GDPs measured in U. S.
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dollars.
Conclusions
• The OCA theory is a suitable framework for
discussing the process of monetary integration in
Europe.
• A big amount of approaches to assessing the
process of monetary integration in the context of
the OCA theory.
• Different results of empirical studies.
• Possible reasons: different methodology,
differences in the length of sample period,
diverse sample of analysed countries …
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