Some of you know I’m keen on the topic of Monetary Union. I find it interesting in the same way that some people find cars interesting or some people find Lord of the Rings interesting. I just wanted to note this idea as I think there is a bit of pessimism regarding the stability of monetary unions as well as the definition. This is by no means an academic essay but here so I can remember my thoughts.
The fact is that the term ‘Monetary Union’ relates to the type of regime. Is, for example, Switzerland a currency union? Well it sort of is and isn’t. It is insofar as there are territorial and economic areas of a defined area which are united under a single monetary area but at the same time it isn’t because it is one entity. There is a highly political element to the definition of what these unions actually are and the difference between the standard state centred currency and a shared currency. This relationship refers to the political nature of its governance.
What the specific difficulty though is not the asymmetry. This is a fairly nationalistic way of looking at it as we are often looking at the boundaries between states. The economies which constitute the union are going to have smaller variation within their boundaries than between due to the long term direction of the economic policies, but there will be a degree of asymmetry within any territory, region, state or even city. That is because economies are not uniformally structured. They all have a degree of asymmetry whether we are looking at Switzerland or the European Union. There will be more opportunity for there to be greater policy divergence between states but we have to recognise that no currency is immune to asymmetry.
Asymmetry for me is the important aspect of any currency union as it has been the source of many a failed currency union. The failure of unions is not based on the asymmetry but the ability of whatever form of governance there is to correct the fault. For example, in a unitary state the regions are all subject to one government and so responsibility over policy and fund transfer goes back to one point. While in a confederal system there is less central direction and the responsibility lies below the point of union. That means that there is more difficulty regarding areas such as moral hazard in the transfer of funds between regions, more difficulty in creating unified policies and difficulty in deciding upon the best type of monetary policy.
Therefore what I tend to think is that the credibility of any currency area or monetary union relies on the ability of the political body at the centre, or the political bodies negotiating, to redistribute funds and create common policies instead of creating some sort of symmetric economic area. Essentially policy makers have to be able to adjust the use of government funds in order to correct asymmetric shocks in the short and long term. This basically means that in order to share a currency; you need to have quite a strong degree of political union. If there is a great deal of policy divergence or even asymmetry then there is a requirement for the governing body to have more tools to deal with the shocks which can occur. If this is not the case then the union will not look credible.