The roles of economic integration and monetary policy in currency unions

In here are some, we discuss both of these issues.

The left panel of Figure 1 shows that there are only not a lot of forces pulling the various countries of a currency union towards one another. This could be the case, nonetheless it does not necessarily must be the case. Economic integration plays a significant role here. The more economically integrated the countries are, that’s, the more open they are one to the other and the more they trade with each other, the stronger is this pulling force. That is intuitive. If a country within an economic depression is economically very integrated with other countries in the currency union whose economies are doing better, the weaker economy should be able to export too much to the stronger economies (due to gaining competitiveness in the downturn), which stabilises the economy. Vice versa, economies in a boom begins importing more from other countries, which dampens the boom. That is stabilising for the currency union all together.

The blue lines in Figure 2 show economic instability in a currency union (CU) as a function of the parameter γ, which may be the parameter representing how economically integrated the countries are (the red line may be the comparison value of a homogeneous economy, and therefore there is a unitary country of similar size as the complete currency union, abbreviated by EC). It really is seen that for a sufficiently advanced of economic integration, economic behaviour in the currency union is stable (instability in this graph is thought as observing deviations greater than 10% from the steady state).

Figure 2 Economic instability based on economic integration

Monetary policy includes a lot of capacity to stabilise the economy in a country that’s not part of a currency union. The central bank can, using its interest decisions, dampen booms and stimulate the economy in a recession. In a currency union, the central bank continues to be of vital importance for the currency union all together – poorly conducted monetary policy may bring the complete currency union into trouble. However, monetary policy faces more limitations in stabilising the economies than it can when being in charge of only one country. It is the case due to differential developments within such a currency union. As the various countries may proceed through completely different economic developments, the central bank will always set mortgage loan that is ‘wrong’ for a few of the countries (if not absolutely all). For the countries that are in a boom the interest (which is defined in response to economic outcomes in the complete currency union) is too low, prolonging the boom. For the countries in a recession, the interest is too much, prolonging the recession. This issue can result in economic instability in the complete currency union.

Economic integration is very important to the functioning of a currency union. Reforms to strengthen this integration are thus useful. However, such reforms are most likely mainly relevant over time. Gleam dependence on stabilisation policies in the short and medium run. Considering that the role that monetary policy can play is somewhat limited, it appears essential to have fiscal policy available as a stabilisation tool at the united states level. This will not mean that there exists a dependence on bigger redistribution between your countries, but countries ought to be able and necessary to use fiscal policy to stabilise their economies.

A currency union that doesn’t function well can incur huge costs. This consists of the suffering of individuals in countries within an economic downturn, and the expenses due to populist parties being elected due to the economic situation. The actual fact that we come to mind about the look of currency unions and the associated problems will not mean that getting into a currency union is necessarily a bad idea. There are potentially large advantages from it, like the lack of risk from fluctuating exchange rates, easier comparability of prices, etc. However the currency union ought to be designed well, so the benefits outweigh the expenses.

Authors’ note: The views expressed in this column are those of the authors rather than necessarily those of the National Audit Office of Lithuania or the lender of Lithuania.

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