Central Bank Flexibility and the Drawbacks to Currency UnificationCentral Bank Flexibility and the Drawbacks to Currency Unification

May 31, 1990

Recently, the benefits to monetary unification have been widely heralded. Advocates of European, as well as East and West German, monetary integration point repeatedly to the advantages the United States derives from possessing a single currency. Yet, the losses resulting from this policy have too often been ignored.

This article briefly reviews the costs and benefits of currency integration as articulated in the traditional optimal currency area literature. For the first time a full-employment model is used to examine the cost to currency unification derived from diversity among countries' distaste for unemployment and inflation. Furthermore, arguments for European monetary integration that highlight the benefits gained by the U.S. currency area are shown to be misleading; not only does the United States suffer significant losses because of its unified currency, but the magnitudes of these costs and benefits will differ between the United States and Europe. Finally, U.S. monetary policy is examined in light of the optimal currency area analysis.

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