Frankel and Rose’s Introduction to the Endogeneity of Optimality: A Model Limited to the European Monetary Experience

Abstract

This article discusses Frankel and Rose’s  (1997, 1998) introduction to endogeneity,  which was the result of scrutinizing the  optimal currency area (OCA) theory through  the evaluative lens of European monetary  integration and unification in the 1990s. It  cannot be generalized to another monetary  union. The development of endogeneity  interrelates five different criteria (common  currency; transaction costs; commercial  integration; economic convergence; and  diversification of production) to argue that the introduction of a common currency  leads to economic convergence among the participating countries. Frankel and Rose’s  choice of analytic criteria arises from  empirical studies on European monetary  unification, following the OCA framework. The  empirical studies found to have influenced  the authors can be divided into three themes:  the microeconomic benefits of a common  currency; the optimality of European countries;  and adjustment mechanisms. However, as  shown by the selection of certain criteria, the influence of the Emerson report (1990), and  the price-stability orientation of fiscal and  monetary policies, their proposal only works  within the monetary and economic conditions  of the future eurozone area.