Center for International and Development Economics Research

In this paper we develop a procedure for applying the core implications of the theory of optimum currency areas to cross-country data. We demonstrate that these implications find strong empirical support. The relationship between the characteristics of countries to which OCA theory points and the observed behavior of exchange rates seems sufficiently stable and robust to support simple forecasting. Extrapolating the independent variables, we therefore use our exchange rate equations to predict which countries will be best able to support stable exchange rates in the future -- equivalently, which are likely to be best prepared to be among the founding members of Europe's monetary union.