Joining always means giving up
independent monetary policy and, with it, a sizeable slice of national
sovereignty. Members relegate the regulation of their money supply,
inflation, interest rates, and foreign exchange rates to a central
monetary authority (e.g., the European Central Bank in the eurozone).
The need for central monetary management arises because, in economic
theory, a currency is never just a currency. It is thought of as a
transmission mechanism of economic signals (information) and
expectations (often through monetary policy and its outcomes).
It is often argued that a single fiscal policy is not only unnecessary,
but potentially harmful. A monetary union means the surrender of
sovereign monetary policy instruments. It may be advisable to let the
members of the union apply fiscal policy instruments autonomously in
order to counter the business cycle, or cope with asymmetric shocks,
goes the argument. As long as there is no implicit or explicit
guarantee of the whole union for the indebtedness of its members -
profligate individual states are likely to be punished by the market,
discriminately.
But, in a monetary union with mutual guarantees among the members (even
if it is only implicit as is the case in the eurozone), fiscal
profligacy, even of one or two large players, may force the central
monetary authority to raise interest rates in order to pre-empt
inflationary pressures.
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