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OPTIMUM CURRENCY AREAS Extended version of a luncheon speech presented at the AConference on Optimum Currency Areas,@ Tel-Aviv University, December 5, 1997 It is a great satisfaction to be the recipient of so much kindness occasioned by my 1961 article on optimum currency areas. I would like to tell you a little about how the article came about, what my intentions were when I wrote it, and then comment on its relevance today. Genesis of the Article The beginnings of the idea first occurred to me in the academic year 1955-6 when I was writing my dissertation under James Meade for MIT at the London School of Economics. My dissertation for MIT, titled AEssays on the Theory of Capital Movements@ was entirely devoted to the real side of the subject--the transfer problem, stability conditions, welfare implications, factor mobility, transport costs, and so forth; it had nothing to do with flexible or fixed exchange rates. Meade, however, was an ardent advocate of flexible exchange rates and it was a hot subject at LSE. He had suggested that the signers of the Treaty of Rome achieve balance of payments equilibrium by letting exchange rates float. At that time I had an open mind on the subject but I could not see why countries that were in the process of forming a common market should saddle themselves with a new barrier to trade in the form of uncertainty about exchange rates. In the next academic year, 1956-57, I was a post-doctoral fellow in political economy at the University of Chicago. Friedman, as you know, like Meade, championed flexible exchange rates. Their reasons were very different. Meade, the liberal socialist, saw flexible exchange rates as a device for achieving external balance while freeing policy tools for the implementation of national planning objectives. Friedman, the libertarian conservative, saw flexible exchange rates as way of getting rid of exchange and trade controls. Both economists saw flexible exchange rates as a means of altering real wages when money wage rigidities would otherwise cause unemployment. The analogy frequently used was that it was easier to put the clocks back than to change people=s habits. As at LSE, flexible exchange rates was a hot subject at Chicago, and it was billed as a free market alternative to fixed exchange rates. It occurred to me here that if the case for flexible exchange rates held for the United States or Canada, it should also hold for any of the regions in those multi-regional countries. But to have flexible exchange rates between regions of the same country, it would be necessary to have more than one currency. Were there not costs associated with the creation of additional currencies? Milton=s answer to my queries on that subject were that if the argument for regional currencies was correct within a particular country, it was a problem that was probably becoming less important as the national economy became more integrated. The upshot however was that I began thinking seriously about the relation between Aregions@ and Acountries@ in the context of monetary systems. Students of trade theory are of the criticism that John H. Williams had made of the classical model of trade, which was based on the supposition that factors of production were mobile internally but immobile internationally. Williams argued that factors were by no means completely mobile inside countries, nor were they completely immobile between countries. Once said, this is obvious, as any glance at history wil