What determines the composition of currency areas? On the necessity of trust between the partners of monetary unions

A currency area is a geographic area where one particular currency is used. The theory of optimum currency areas (OCAs), initiated by Mundell in 1961, is the standard tool used to evaluate the advisability of the extent of cu rrency areas. According to the theory, an optimum design can be achieved by balancing the macroeconomic stabilisation costs and microeconomic benefits that would result from enlarging a particular currency area. The OCA theor y accounts for the economic costs associated by currency area delimitation. Still, it cannot account for the composition of actual currency areas - of ten relatively large and delimited by administrative and political, not eco nomic, boundaries. That most currency areas coincide with single nation sta tes suggests that political factors strongly impact on currency area design . Generally, the introduction of a common currency entails uncertain, poten tially far-reaching consequences that cannot be fully regulated by formal a greements. Thus, a high level of mutual trust will be required between gove rnments that contemplate monetary unification. The establishment of the Eur opean monetary and economic union (EMU), a rare example of a multinational currency union, is used as an illustration.