This paper re-examines the debate on the instability of the Euro-area. We propose a theory of Optimum Financial Areas (OFA) that focuses on the governance of capital flows and ‘financial market geography’ free of a single currency per se. Instability in the euro area was the consequence of instability in financial market integration, not the other way around. The problem is to prevent the disintegration of the cross-border banking system and debt markets created by the single currency wherein savers from one part of the ‘union’ call back their investments in another. OFA theory draws inductively on historical cases of national monetary integration to demonstrate in functional terms that the political economy of European financial integration has generated institutional lacunae that go well beyond the current debate on Banking union and swing free of ‘transfer unions’ or other forms of distributional conflict. OFA proposes six interlocking sets of discretionary instruments to prevent such sudden stops in the future.
