“ runs ” on bank and sovereign debt absent central bank support. 6 such adverse feedback loops turned recessions into depressions in several european countries in recent years. what makes a successful currency union? the success of a currency area hinges on whether its features mitigate the costs of losing the flexibility that comes from an independent monetary policy. these features generally promote the alignment of economic cycles, and the maintenance of price and financial stability within the union. the most obvious feature is the degree of similarity amongst members. similar economies won ’ t suffer from a “ one size fits all ” monetary policy. 7 surprisingly, a review of major currency areas suggests that similarity is neither necessary nor sufficient for success. for example, the industrial structures of the core and periphery of the euro area are more similar than those of the constituents of canada or the us ( table 1 ). yet few would argue that the euro area is the most effective currency union of the three. conversely, the canadian monetary union works well despite having substantially larger industrial variation than even the us. 8 the similarity of the industrial structure of scotland and the rest of the uk depends on how offshore oil is allocated. with oil split on a per capita basis scotland and the rest of the uk look about as similar as the core and periphery of the euro area ; but with oil split on a geographic basis they look about as diverse as the united states ( table 1 ). despite any differences, the close integration of the scottish and rest of uk economies has helped ensure that their economic performance has been very similar over a long period – output growth is highly correlated ( chart 1 ). 9 so theory notwithstanding, being similar doesn ’ t necessarily help and being different doesn ’ t necessarily hinder. this suggests we should look elsewhere for the ingredients of a successful union : to the mobility of labour, capital and goods ; to institutional structures promoting financial stability ; and to institutions that mutualise risks and pool fiscal resources. an economic union with free movement of labour, capital and goods the “ five tests ” formulated by the uk government to analyse the merits of joining the euro in 2003 were crafted in large part around the degree of integration of the uk and the euro area. 10 that is because greater openness and integration within a currency union not only enhances these dynamics were in operation in the recent euro area crisis, until the announcement of the ecb ’ s outright monetary transactions. members are similar when they experience similar shocks and respond to the same shock in similar ways. that reduces

also assists in diluting the effect of shocks by spreading them across the union. if one part of the union imports a large share of what it consumes from other parts, changes in demand will be quickly transmitted. this helps to align economic cycles and makes a common monetary policy more appropriate. 16, 17 the classic early contribution on this point was made by mckinnon ( 1963 ), who argued that the more open the economy, the more flexible would be domestic prices and wages so that movements in the exchange rate would have little impact on competitiveness, and would be less effective as a stabiliser. in that case moving to a fixed exchange rate would be less costly. mundell ( 1961 ). some, including bean ( 1992 ), have expressed scepticism that factors of production could in fact move over a shorter timescale than that over which prices and wages adjust. this is consistent with evidence that labour moves less in europe in response to regional shocks than is the case in the us – see blanchard and katz ( 1992 ) for the us, and decressin and fatas ( 1995 ) who apply the same methodology to europe. the latter find that participation reacts by more to a labour demand shock, and migration by less in europe than the us. office for national statistics, 2011 census. frankel and rose ( 1998 ) found that countries with closer trade links tend to have more tightly correlated business cycles. since joining a currency area promotes trade integration, it also is also likely to help align international business cycles. that means one of the key optimum currency area criteria is endogenous to the decision to join. rose ’ s ( 2009 ) more recent meta - analysis also finds a significant effect of trade on the synchronisation of business cycles. de grauwe ( 2000 ) provides a discussion of how closer integration may affect the likelihood that countries experience asymmetric shocks. on the one hand closer trade links could result in greater specialisation, leaving currency union members more prone to asymmetric shocks. on the other, it could result in more intra - industry trade, increasing the likelihood that countries will experience similar shocks, and thereby helping to align business cycles. a high degree of openness also means that the adjustment required to boost net exports is somewhat lower. a much weaker adjustment in prices and wages is necessary to raise net exports by a given share of gdp if both exports and imports are a large share of gdp than if they are a small share