In part, this is because domestic firms will be enabled to participate more readily in external trade because of the absence of exchange rate risk. According to an estimate of this trade boost effect if Iceland were a member of the euro area (see Chapter 8), goods trade relative to GDP could increase by 4–11 percentage points and, as a result, GDP per capita could rise permanently by 1½–11%. •  Research shows as well that the increased trade between member countries with a common currency could cause the business cycle in those countries to become more symmetric over time, so that OCA criteria are met to a gradually increasing degree. •  The use of money is subject to considerable economics of scale; for instance, in connection with currency issuance, the cost of providing monetary services (such as monetary policy and payment intermediation), and cross-border foreign exchange transactions. Other things being equal, participation in a larger currency area would lead to a more efficient and less expensive monetary system. •  In addition, small countries in a currency union can save foreign exchange reserves to a greater degree than is possible with an independent currency. •  The domestic foreign exchange market is small, undeveloped, and relatively expensive to trade in (see Chapter 12). Euro area membership would provide access to a large, deep financial market without exchange rate risk. This would facilitate risk diversification domestically.
Finally, if economic shocks extend only to the home country and joint monetary policy is insufficient to absorb the shock, labour market flexibility could take the place of nominal exchange rate adjustment once the domestic currency has been abandoned. Consideration of these criteria based on historical data does not produce an unequivocal answer about Iceland’s suitability as a member of the eurozone. The Icelandic business cycle has been rather weakly linked to that of the euro area – and actually, to most other regions and countries as well (see Chapter 10). Iceland’s export sector differs in structure from that in most other industrialised countries (see Chapter 4). On the other hand, the economy is quite open to trade and the euro area is by far Iceland’s largest trading partner (see Chapters 4, 8, and 20). In addition, the domestic labour market is quite flexible, although downward flexibility of nominal wages has not been tested much and available data suggest that it has been relatively limited to date (see Chapter 14). The OCA theory has many shortcomings and does not take account of a number of potential benefits of participation in a large currency area such as the eurozone. Historical experience also suggests that currency unions can be successful even if the participating countries do not fulfil the OCA criteria at the outset (see Chapter 5). In this context, the following points are worth noting: •  Research indicates that currency union membership will stimulate trade with the currency union without reducing trade with other countries.