What theory establishes criteria for the optimal size of an area sharing a common currency?

The theory that establishes criteria for the optimal size of an area sharing a common currency is known as the Optimum Currency Area (OCA) theory. This concept was developed by economist Robert Mundell in the 1960s and outlines the necessary conditions under which a region can benefit from adopting a common currency.

According to the OCA theory, regions sharing a currency should ideally have a high degree of economic integration, similar business cycles, and mobility of labor and capital. The rationale is that in a currency union, the loss of the ability to manipulate exchange rates and monetary policy can be offset by other factors, such as increased trade, economic stability, and reduced transaction costs.

In contrast, the other concepts mentioned do not specifically address the criteria for optimal currency regions. The Single European Act focuses on creating a single internal market within the European Community; Monetary Union Theory broadly relates to linking different currencies and their implications rather than specifying optimal regional conditions; and the European Stability Pact pertains to preventing excessive budget deficits and ensuring fiscal discipline among EU nations. Therefore, the OCA theory is the most relevant framework for analyzing the optimal size and characteristics of areas adopting a common currency.