Definition
Monetary Union
A common market between countries who also share a common currency and a common central bank.
Compared to common markets, monetary unions have a greater level of integration since they share a:
- Common currency: All member countries use the same currency.
- Common central bank: A single central bank manages the monetary policy for all member countries.
The Eurozone is a monetary union where 19 of the 27 European Union (EU) countries use the euro (€) as their common currency, managed by the European Central Bank (ECB).
Regardless of the level of economic integration that monetary unions possess, it has its advantages and disadvantages (4.4.5 Advantages & Disadvantages of Monetary Union HL).
Tip
It is advised to learn and understand 4.5 Exchange Rates and 4.6 Balance of Payments before reading the content below.
This is because relevant concepts from the two topics are discussed below.
Advantages of monetary unions
Exchange rate certainty
- A common currency eliminates the risk of exchange rate changes between member countries.
- Therefore, it reduces uncertainties for traders and investors, who might have needed to predict future exchange rates.
- Further, this stability encourages trade and investment within the union as:
- It removes the hassle of exchanging currencies, benefitting importers and exporters.
- This leads to easy trade and investments, which helps achieve a more efficient allocation of resources.
Price Transparency
- This is the ability for producers and consumers to be able to perform price comparisons in any member country without having to do calculations or conversions.
- Therefore, it allows economic decision-makers to observe price differences and price comparisons which is more accurate and faster to retrieve.
- This could lead to promoting competition and efficiency, which could cause lower prices for consumers.
No Transaction Costs
- Both consumers and producers save money by not needing to exchange currencies and pay a fee to the bank or institution for the conversions.
- These savings can be significant and could lead to further trade and investments.
Increased Inward Investments
- The absence of exchange rate risks makes monetary unions more appealing for foreign direct investment (FDI).
- Therefore, with higher FDI, there will be higher economic growth and job creation.
