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A currency union (also known as monetary union) is an intergovernmental agreement that involves two or more states sharing the same currency. These states may not necessarily have any further integration (such as an economic and monetary union, which would have, in addition, a customs union and a single market).

There are three types of currency unions:

The theory of the optimal currency area addresses the question of how to determine what geographical regions should share a currency in order to maximize economic efficiency.

Advantages and disadvantages of currency unions

Implementing a new currency in a country is always a controversial topic because it has both many advantages and disadvantages. New currency has different impacts on businesses and individuals, which creates more points of view on the usefulness of currency unions. As a consequence, governmental institutions often struggle when they try to implement a new currency, for example by entering a currency union.

  • A currency union helps its members strengthen their competitiveness in a global scale and eliminate the exchange rate risk.
  • Transactions among member states can be processed faster and their costs decrease, fees to banks are lower as a single currency is used.
  • Prices are more transparent and therefore easier to compare. That supports fair competition.
  • The possibility of monetary crisis is lower. The more countries there are in the currency union, the more resistant to crisis they are together.
  • The member states lose their sovereignty in monetary policy decisions. There is usually an institution (such as a central bank) that takes care of the monetary policy making in the whole currency union.
  • The risk of assymetric "shocks" may occur. The criteria set by the currency union are never perfect, so a group of countries might be substantially worse off while the others are booming.
  • Implementing a new currency causes high financial costs. Businesses and also single persons have to adapt to the new currency in their country, which includes costs for the businesses to prepare their management, employees, and they also need to inform their clients and process plenty of new data.
  • The unlimited capital movement may cause moving most resources to the more productive regions at the expense of the less productive regions. The more productive regions tend to attract more capital in goods and services, while the less productive regions might be missing those.[2][3]

Convergence and divergence

Convergence in terms of macroeconomics means that countries have a similar economic behaviour (similar inflation rates and economic growth). It is easier to form a currency union for countries with more convergence as these countries have the same or at least very similar goals. The European Monetary Union (EMU) is a contemporary model for forming currency unions. Membership in the EMU requires that countries follow a strictly defined set of criteria (the member states are required to have specific rate of infaltion, government deficit, government debt, long-term interest rates and exchange rate). Many other unions have adopted the view that convergence is necessary, so they now follow similar rules to aim the same direction.

Divergence is the exact opposite of convergence. Countries with different goals are very difficult to integrate in a single currency union. Their economic behaviour is completely different, which may lead to disagreements. Divergence is therefore not optimal for forming a currency union.[4]

History of currency unions

The first currency unions were established in the 19th century. The German Zollverein came into existence in 1834, and by 1866, it included most of the German states. The fragmented states of the German Confederation agreed on common policies in order to increase trade and political unity.

The Latin Monetary Union, comprising France, Belgium, Italy, Switzerland and Greece, existed between 1865 and 1927, with coinage made of gold and silver. Coins of each country were legal tender and freely interchangeable across the area. Because of the success of the union other states joined later informally.

The Scandinavian Monetary Union, comprising Sweden, Denmark and Norway, existed between 1873 and 1905, and used a currency based on gold. The system was dissolved by Sweden in 1924.[5]

List of currency unions

Note: Every customs and monetary union and economic and monetary union also has a currency union.

Zimbabwe is theoretically in a currency union with four blocs as the South African rand, Botswana pula, British pound and US dollar freely circulate, the US Dollar was until 2016 official tender. [1] [28] .

Additionally the autonomous and dependent territories, such as some of the EU member state special territories, are sometimes treated as separate customs territory from their mainland state or have varying arrangements of formal or de facto customs union, common market and currency union (or combinations thereof) with the mainland and in regards to third countries through the trade pacts signed by the mainland state.[14]

The European currency union is a part of the Economic and Monetary Union of the European Union (EMU). EMU was formed during the second half of the 20th century after historic agreements, such as Treaty of Paris (1951), Maastricht Treaty (1992). In 2002, Euro, a single European currency, was adopted by 12 member states. Currently, the so called Eurozone has 19 member states. The other members of the European Union must adopt the Euro as their currency (with exceptions, such as the UK and Denmark), but there has not been a specific date set. The main independent institution responsible for stability of the Euro is the European Central Bank (ECB). Together with 15 national banks it forms the European System of Central Banks. The Governing Board consists of the Executive Committee of the ECB and the governors of individual national banks, and determines the monetary policy, as well as short-term monetary objectives, key interest rates and the extent of monetary reserves.[15]

  • proposed pan-American monetary union – abandoned in the form proposed by Argentina
  • proposed monetary union between the United Kingdom and Norway using the pound sterling during the late 1940s and early 1950s
  • proposed gold-backed, pan-African monetary union put forward by Muammar Gaddafi prior to his death

See also

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