Endogenous OCA (Optimum Currency Area) Analysis and the Early Euro Experience

Some have argued that the endogenous responses to the formation of a currency area are so strong that one need not worry about optimum currency area conditions ex ante. We argue that this is much too strong a conclusion. We draw on a number of recent studies to evaluate the endogeneity experiences of the eurozone in three major areas; trade flows, business cycle synchronisation and structural reforms to improve labour and product market flexibility. Simple before-and-after comparisons are insufficient for analysis of endogeneity. The experiences of non-euro Western European economies suggest that broader trends also had considerable influence on trade and business cycle patterns. While trade rose substantially within the eurozone, it also rose with and among other European economies. We argue that political economy considerations tend to dampen the magnitude of endogeneity efforts on structural reforms and that meeting conditions for entry may be a more powerful mechanism in this than are subsequent endogenous responses. We also discuss a number of areas for further research