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The theory of optimum currency areas: a critique

3 important questions on The theory of optimum currency areas: a critique

In a case of an hard-nosed open economy (Germany) and a wet open economy (Italy), if inflation of Italy is larger than Germany, the Italian currency should depreciate. Italy can achieve a much lower inflation rate if it convinces it citizens that it does not unexpectedly increase inflation. Why does this not work?

The government has an incentive for surprise devaluation, which leads to an inflation and over time, the same equilibrium is reached; i.e. not credible .

Based on which arguments did Mundell contribute to a more optimistic view about the EMU?

1. a MU is a more efficient way to organize an insurance against asymmetric shocks than a system with national moneys and uncertain exchange rates
2. in an uncertain world, exchange rate movements are likely to be a source of asymmetric shocks, which are often driven by psychological and behaviour factors instead of being a mechanism to adjust for them against shocks

How can the risk of adjustment costs in the face of asymmetric disturbances be reduced?

1. make markets more flexible, so that asymmetric shocks adjust better
2. speed up the process of political unification to decrease asymmetry of shocks with political origin