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3, the world of Mundell II is one where the OCA-line is close to the origin. As a result, the present euro-zone is likely to be safely embedded in a large OCA-zone. So, it appears at first sight that in the Mundell II world monetary unions can be sustained more easily without having to take the difficult steps of political unification. This is quite a comfortable thought for the euro-zone member countries who find it difficult to move forward into a political union. It will therefore be no surprise that the Mundell II analysis has become the favoured official frame of thinking about the subject.

Likewise it is obvious that firms and other domestic actors would take local inflation rates into account when making their investment decisions. What is less obvious is how domestic actors are using domestic inflation rates in their discounting. To understand this point it is necessary to consider the microeconomic foundations for the influence of real interest rates on investment. The standard notion is that the real interest rate represents the cost of borrowing or the opportunity cost of forgoing a financial investment in order to purchase plant, equipment or other capital goods.

Animal spirits’, that is to say waves of optimism and pessimism, capture consumers and investors. These waves have a strong element of self-fulfilling prophecy. When pessimism prevails, consumers and investors alike hold back their spending, thereby reducing output and income, and validating their pessimism. Similarly, when optimism prevails, consumers and investors will spend a lot, thereby increasing output and income, and validating their optimism. The corollary of this effect is the well-known savings paradox.

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