Monetary Union can have both a political (like euro zone) or an economic ( the planned monetary union of GCC) agenda. In case of political agenda, it is generally intended to bring in more integration and interdependence to set off rivalries and prevent wars. This requires that the countries should have similar populations, per capita GDP and also should have the similar makeup of their economy and exports. ( As is evident in the case of Europe, South East Asia, Latin America or the GCC ststes). In addition, there should be sufficient mobility of labor and flexibility in wages to be able to adjust to external economic environ.
Benefits:
Major benefits..
1. Decreases costs of transactions. (hence, useful for states with higher proportions of trade among themselves)
2. Removes uncertainty related to currency exchange rate fluctuation. (Brings in stable currency, always good for the economy)
3. Facilitates freer movements of capital, labor and goods.
Minor benefits..
1. Easier for people- especially in price and cost comparison.
2. It is expected that a common central bank may prove more effective than that of individual
country in formulating monetary policies
Costs:
1. Loss of sovereignty (both perceived and real)- People fear that the bigger economies may exert more power over smaller ones.
2.Loss of option to regulate monetary policies- As the recent Euro crisis suggests, Greece and other PIIGS countries now don't have an option of devaluation thanks to a common currency.
Also, can't regulate the interest rates. So, in effect, no control over currency.
(Hence, it means that if a country has very definite laws regulating it's economic sphere e.g. the UK,
it may find it harmful to join a monetary union as then it's left with almost no tools to generate flexibility in the market when a crisis comes up.)
3.Adjusting to a new currency is not so easy
Under a currency union, there is no scope for independent monetary policies by the member countries of the union. However, the cost associated with the loss of monetary independence depends upon how well the individual countries were conducting monetary policy prior to joining the currency union. Many developing countries with open capital accounts have several constraints in the effective conduct of an independent monetary policy. This is especially so in developing countries with thin capital markets and weak central banking institutions. In general, the record of developing countries in conducting independent national monetary policies to minimize cyclical fluctuations in economic activity has been somewhat patchy. This suggests that the economic loss from giving up an independent monetary policy may not be very large for such countries. On the contrary, a currency union may, in fact, elicit commitment to greater macroeconomic stability from countries that otherwise have a mixed track record in implementing monetary policy prior to joining the currency union (Barro 2001). It is possible that this benefit will compensate for the loss of monetary policy autonomy.
The benefits of a currency union increase and/or the costs decrease with
(i) greater flexibility in wages and prices among the countries of the union,
(ii) greater mobility of factors of production (labor and capital) across countries,
(iii) more symmetric shocks across countries,
(iv) more openness among the economies within the union, and
(v) larger share of trade among the countries of the region.
Sustaining a common currency may be even more difficult than adopting it. Four constraints that have generally been mentioned are worth special attention:
(i) diversity in the level of economic development across countries,
(ii) weaknesses in the financial sectors of many countries,
(iii) inadequacy of region-level resource pooling mechanisms and institutions required
for forming and managing a currency union, and
(iv) lack of political preconditions for monetary cooperation and a common currency.
Benefits:
Major benefits..
1. Decreases costs of transactions. (hence, useful for states with higher proportions of trade among themselves)
2. Removes uncertainty related to currency exchange rate fluctuation. (Brings in stable currency, always good for the economy)
3. Facilitates freer movements of capital, labor and goods.
Minor benefits..
1. Easier for people- especially in price and cost comparison.
2. It is expected that a common central bank may prove more effective than that of individual
country in formulating monetary policies
Costs:
1. Loss of sovereignty (both perceived and real)- People fear that the bigger economies may exert more power over smaller ones.
2.Loss of option to regulate monetary policies- As the recent Euro crisis suggests, Greece and other PIIGS countries now don't have an option of devaluation thanks to a common currency.
Also, can't regulate the interest rates. So, in effect, no control over currency.
(Hence, it means that if a country has very definite laws regulating it's economic sphere e.g. the UK,
it may find it harmful to join a monetary union as then it's left with almost no tools to generate flexibility in the market when a crisis comes up.)
3.Adjusting to a new currency is not so easy
Under a currency union, there is no scope for independent monetary policies by the member countries of the union. However, the cost associated with the loss of monetary independence depends upon how well the individual countries were conducting monetary policy prior to joining the currency union. Many developing countries with open capital accounts have several constraints in the effective conduct of an independent monetary policy. This is especially so in developing countries with thin capital markets and weak central banking institutions. In general, the record of developing countries in conducting independent national monetary policies to minimize cyclical fluctuations in economic activity has been somewhat patchy. This suggests that the economic loss from giving up an independent monetary policy may not be very large for such countries. On the contrary, a currency union may, in fact, elicit commitment to greater macroeconomic stability from countries that otherwise have a mixed track record in implementing monetary policy prior to joining the currency union (Barro 2001). It is possible that this benefit will compensate for the loss of monetary policy autonomy.
The benefits of a currency union increase and/or the costs decrease with
(i) greater flexibility in wages and prices among the countries of the union,
(ii) greater mobility of factors of production (labor and capital) across countries,
(iii) more symmetric shocks across countries,
(iv) more openness among the economies within the union, and
(v) larger share of trade among the countries of the region.
Sustaining a common currency may be even more difficult than adopting it. Four constraints that have generally been mentioned are worth special attention:
(i) diversity in the level of economic development across countries,
(ii) weaknesses in the financial sectors of many countries,
(iii) inadequacy of region-level resource pooling mechanisms and institutions required
for forming and managing a currency union, and
(iv) lack of political preconditions for monetary cooperation and a common currency.
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