Costs and Benefits of Monetary Integration

Quickjump Contents Fixed Exchange Rates Optimum Currency Areas Costs and Benefits European Monetary System Transition to EMU Fiscal Policy and EMU The European Central Bank Costs of UK Policy Bibliography < >

EMU objectives

1. Single market
2. Price stability
3. Exchange rate flexibility

Openness & potential costs of EMU

• devaluation has a much greater effect in a very open country, where exports are a large proportion of its GDP
• after devaluation the supply curve shifts more in the open country & thus it has a greater effect than a relatively closed economy
• the result is price instability for the open economy
• so losing the ability to devalue is less important for very open economies as their prices would suffer a lot of variability
• cost of EMU thus falls with openness of economy

Monetary Integration: costs versus benefits

Costs

• Loss of exchange rate
• Loss of monetary autonomy
• Constraints on fiscal policies

Benefits

• Price transparency
• Increased efficiency – no need to plan for exchange rate fluctuations – especially for importers who would have to bare hedging costs
• Reduced transaction costs
• No need to have foreign currency reserves for central banks – no separate currency to protect
• Exchange rate stability – international firms’ pricing, investment, export markets
• Reduced interest rates
• Increased policy credibility because devaluation is not possible
• less uncertainty from moral hazard, adverse selection due to overly high or low interest rates
• increased growth especially endogenous growth
• firms: all the benefits reduce costs for firms & thus increase their competitiveness
• consumers: receive a welfare increase from increase consumer surplus from the lower prices & reduced uncertainty

Business cycle alignment is really the key issue

• and also whether or not there is enough factor (Capital and Labour) mobility