Monetary Unions In Europe

Abstract

Monetary unions essentially require either one currency or absolute fixity of exchange rates for the union’s member currencies with respect to one another. There is no substantive economic difference (apart from the profits of seigniorage) between the case of a single currency and absolutely fixed (or to use the Maastricht formula “irrevocable”) exchange rates. Thus both Panama and Hong Kong are in the dollar monetary union, but the former has the greenback as its currency whereas Honk Kong’s own currency, the Hong Kong dollar, circulates and exchanges at a fixed parity of 7.8 to the greenback. But in both cases the Federal Reserve Board in Washington D.C. determines monetary policy. And of course the Fed never mentions Hong Kong, let alone Panama, in determining monetary policy. Clearly interest rate and open market policy are attuned to domestic economic conditions in the United States. If Hong Kong and Panama find this policy damaging to their interests, then, say the Fed, they are at liberty to break the fix. If they don’t like it they can “lump it.”