Monetary union is a further development of economic union in which member countries adopt a common currency. The term is also known as a currency union.
How does the European Monetary Union work?
In a monetary union, goods, services, and factors of production move freely between member countries. They also have a uniform trade policy with non-members. Furthermore, monetary union involves the adoption of a joint monetary policy. For this reason, member countries form economic institutions to coordinate joint economic policies. An example is the European Central Bank, which is responsible for coordinating monetary and economic policies in member countries.
The Economic and Monetary Union (EMU) was established in 1992 as a result of the Maastricht Treaty and is the forerunner of the European Union (EU). The EU does involve not only the common market but also the coordination of economic policies between all member countries.
In January 1999, the European Central Bank (ECB) coordinated the monetary policies of all members and introduced the single currency, the Euro. As of 2019, the Euro is the official currency of 18 of the 28 EU member states. They are Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.
Benefits and drawbacks
Monetary unions provide credibility for all members, even for countries that have a history of monetary or fiscal indiscipline.
Economic integration also involves free movement, not only goods and services but also factors of production. Elimination of transaction costs leads to a cheaper supply of goods and a more efficient allocation of resources.
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With cooperation, the market is getting bigger. It also raises new competition because companies can move freely among member countries. Increased competition leads to efficiency, price transparency, and technological innovation.
Bargaining power in international negotiations is getting stronger. With higher economic power, they have a stronger position and are relatively more resistant to crises. The adoption of a shared currency also reduces exchange rate fluctuations because it is more resistant to speculators.
However, the integration and adoption of a shared currency do not mean that members will have the same creditworthiness. Take a case of the European Union. Although the European Union received an AA rating from Standard & Poor’s, the ratings vary for member countries. From the same rating agency, Germany received an AAA rating, France at AA, Greece at BB+, and Italy at BBB.
Furthermore, member countries cannot carry out monetary policy independently. Member states lose their sovereignty in monetary policy decisions. They must coordinate with other member countries, which may have conflicting goals.