Advantages + Disadvantages of Monetary Unions

Monetary Union

• Bloc of countries

• Same currency

• Same central bank

• Same monetary policies

Advantages

1. Non-fluctuating exchange rate

2. Reduced costs from currency conversion

3. Increased business confidence

4. Currency is more stable against speculation

5. Prices between countries are easier to compare

1. Non-fluctuating exchange rate

• Becomes much easier to trade (export and import) due to the stability of the euro

Purchasing power parity

The rates of currency conversion that try to equalise the purchasing power of different currencies, by eliminating the differences in price levels between countries.

2. Reduced costs from currency conversion

• Benefits consumers as their is increased money that can be used on European goods and services

• Businesses save - Gets rid of the cost of converting whilst trading - decreases cost of importing/exporting - this money can be used for investment purposes

3. Increased business confidence

• greater investment if currency is more stable

• Exporting/ importing firms can plan for the future - due to the lack of fluctuations firms can predict the price of a good or service

• Planning for investment becomes much easier

4. Currency is more stable against speculation

• Unlikely that the currency will be over/under-valued

5. Price comparison is much easier

• Removes the cognitive load of having to take into consideration different currencies

Disadvantages

1. Loss of monetary policy autonomy

2. No potential for countries to alter their exchange rates

3. Cost of currency conversion is very high

4. Lack of fiscal union

1. Loss of monetary policy autonomy

• If the economic situation is different to than other countries within the trading bloc the monetary policy set won’t be suitable for that nation

• Can lead to credit based bubbles in already prosperous economies

• Loses the ability to print money and manipulate interest rates

Credit based bubbles

Occurs when there is excessive borrowing and lending, often driven by the expectation that asset prices will continue to rise

2. No potential for countries to alter their exchange rates

• Cannot manipulate exchange rates to boost trade performance

  • Eg: if a country was in need of export based growth then the country wouldn’t be able to depreciate their currency to facilitate that growth (SPICED)

3. Cost of currency conversion = very high

• Taking out one currency and replacing it with another currency in the market is very high

  • Physical costs are very high - ie. printing new money, taking in all the old notes and coins

4. Lack of a fiscal union

• Countries that are reckless with their fiscal policies can wreck the entire union

  • Over spending and inefficiency with tax collection could result in a country having to leave the euro due to the possibility of bankruptcy

  • If one country faces recession or shocks, it cannot rely on fiscal transfers or shared resources from the union.

  • This puts more strain on national fiscal policy, which is often constrained by debt limits and market reactions.

Austerity measures

A set of government policies aimed at reducing budget deficits and/or public debt by decreasing government spending or increasing taxes