Optimum Currency Area Theory

DEFINITION of 'Optimum Currency Area Theory'

A currency thoery based on geographical area that adopts a fixed exchange rate regime or a single currency within its boundaries. Optimum currency area theory can benefit a region by greatly increasing trade, but must outweighs the costs of giving up the national currency as an instrument to adjust monetary policy to be effective. An optimum currency area theory also maintains a flexible exchange rate system with the rest of the world. The theory was popularized by economist Robert Mundell in 1961.

BREAKING DOWN 'Optimum Currency Area Theory'

The creation of the euro in 1999 is often cited as a prime example of an optimum currency area theory. However, the theory was put to the test in 2010 as sovereign debt issues faced by a number of heavily indebted nations in Europe threatened the viability of the European Union and placed severe strains upon the euro.