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The literature on optimum currency areas differs from that on other topics in economic theory in a number of notable respects. Most obviously, the theory is framed in verbal rather than mathematical terms. Mundell’s seminal article coining the term and setting out the theory’s basic propositions relied entirely on words rather than equations. The same was true of subsequent contributions focusing on the sectoral composition of activity and the role of fiscal flows. A handful of more recent articles specified and analyzed formal mathematical models of optimum currency areas. But it is safe to say that none of these has “taken off” in the sense of becoming the workhorse framework on which subsequent scholarship builds. The theoretical literature remains heavily qualitative and narrative compared to other areas of economic theory. While Mundell, McKinnon, Kenen, and the other founding fathers of optimum-currency-area theory provided powerful intuition, attempts to further formalize that intuition evidently contributed less to advances in economic understanding than has been the case for other theoretical literatures. Second, recent contributions to the literature on optimum currency areas are motivated to an unusual extent by a particular case, namely Europe’s monetary union. This was true already in the 1990s, when the EU’s unprecedented decision to proceed with the creation of the euro highlighted the question of whether Europe was an optimum currency area and, if not, how it might become one. That tendency was reinforced when Europe then descended into crisis starting in 2009. With only slight exaggeration it can be said that the literature on optimum currency areas became almost entirely a literature on Europe and on that continent’s failure to satisfy the relevant criteria. Third, the literature on optimum currency areas remains the product of its age. When the founders wrote, in the 1960s, banks were more strictly regulated, and financial markets were less internationalized than subsequently. Consequently, the connections between monetary integration and financial integration—whether monetary union requires banking union, as the point is now put—were neglected in the earlier literature. The role of cross-border financial flows as a destabilizing mechanism within a currency area did not receive the attention it deserved. Because much of that earlier literature was framed in a North American context—the question was whether the United States or Canada was an optimum currency area—and because it was asked by a trio of scholars, two of whom hailed from Canada and one of whom hailed from the United States, the challenges of reconciling monetary integration with political nationalism and the question of whether monetary requires political union were similarly underplayed. Given the euro area’s descent into crisis, a number of analysts have asked why economists didn’t sound louder warnings in advance. The answer is that their outlooks were shaped by a literature that developed in an earlier era when the risks and context were different.


Martin D. D. Evans and Dagfinn Rime

An overview of research on the microstructure of foreign exchange (FX) markets is presented. We begin by summarizing the institutional features of FX trading and describe how they have evolved since the 1980s. We then explain how these features are represented in microstructure models of FX trading. Next, we describe the links between microstructure and traditional macro exchange-rate models and summarize how these links have been explored in recent empirical research. Finally, we provide a microstructure perspective on two recent areas of interest in exchange-rate economics: the behavior of returns on currency portfolios, and questions of competition and regulation.