The Endogenity of the Optimum Currency Area Criteria

TLDR

A country's suitability for a currency union depends on economic conditions such as trade intensity and business‑cycle correlation, both of which are endogenous. This paper develops and investigates the relationship between trade link intensity and business‑cycle correlation. Analysis of thirty years of data for twenty industrialised countries shows that closer trade links are associated with tighter business‑cycle correlation.

Abstract

A country' suitability for entry into a currency union depends on a number of economic conditions. These include, inter alia, the intensity of trade with other potential members of the currency union, and the extent to which domestic business cycles are correlated with those of the other countries. But international trade patterns and international business cycle correlations are endogenous. This paper develops and investigates the relationship between the two phenomena. Using thirty years of data for twenty industrialised countries, we uncover a strong and striking empirical finding: countries with closer trade links tend to have more tightly correlated business cycles.