Publication

On the Benefits of a Monetary Union: Does it Pay to Be Bigger?

Chiara Forlati
2013
Report or working paper
Abstract

This paper revisits the question of the appropriate domain of a currency area using a New-Keynesian open economy model in which the world is split in two areas, each framed as a continuum of small open regions. We show that the adoption of a common currency like the euro can be beneficial for the members of the monetary union, since the spill-over effects within and across areas generated by the inflationary policies of the small open economies are likely to outweigh the costs of not tailoring monetary policy to country-specific shocks. We also show that while enlargement of the monetary union to another group of small open economies can bring about welfare gains for all countries involved, monetary integration of two large economies, such as the euro area and the U.S., will not. These findings can rationalize the process of the creation and enlargement of the eurozone.

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Related concepts (33)
Currency union
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: Informal – unilateral adoption of a foreign currency. Formal – adoption of foreign currency by virtue of bilateral or multilateral agreement with the monetary authority, sometimes supplemented by issue of local currency in currency peg regime.
Optimum currency area
In economics, an optimum currency area (OCA) or optimal currency region (OCR) is a geographical region in which it would maximize economic efficiency to have the entire region share a single currency. The underlying theory describes the optimal characteristics for the merger of currencies or the creation of a new currency. The theory is used often to argue whether or not a certain region is ready to become a currency union, one of the final stages in economic integration. An optimal currency area is often larger than a country.
Currency
A currency is a standardization of money in any form, in use or circulation as a medium of exchange, for example banknotes and coins. A more general definition is that a currency is a system of money in common use within a specific environment over time, especially for people in a nation state. Under this definition, the British Pound Sterling (£), euros (€), Japanese yen (¥), and U.S. dollars (US$) are examples of (government-issued) fiat currencies.
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