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European Monetary Integration

Past, Present and Future

Edited by Eric J. Pentecost and André Van Poeck

This highly topical book examines the development and future prospects for economic and monetary union in Europe. European Monetary Integration examines the background to economic and monetary union from a historical perspective that distinguishes between national and supranational currency areas, and an optimal currency area theory. The gradualist transition process is also considered.
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Chapter 4: The theory of monetary union and EMU

Anke Jacobsen and Horst Tomann


Anke Jacobsen and Horst Tomann 1 INTRODUCTION The history of European monetary integration, as discussed in Chapter 2, shows that there have been political as well as economic forces driving the process of integration. In this chapter the theory of monetary union is considered, with its implications for the European Union (EU). If politicians decide on issues of monetary integration, what economic reasons should they take into account? In particular, if they are free to decide on a monetary regime, what would be the size of the optimum currency area? In dealing with these questions in a theoretical framework we should be aware, however, that politicians may not be as free as it might seem. There is an immanent logic of economic integration. Whenever trade opportunities are realized in international trade, rules and agreements are required concerning the convertibility of the currencies involved. Moreover, with expanding international markets for tradable goods firms recognize their specific financial requirements. Furthermore if a substantial market share is obtained in export markets, foreign direct investment may become a more attractive option than exporting. Thus trade, finance and direct foreign investment induce an increasing demand for deregulation of financial markets. National authorities may, however, be reluctant to deregulate financial markets. The liberalization of international financial flows requires perfectly convertible currencies. Governments must therefore be in a position to defend their exchange rates. If, by contrast, they fear that private agents are not prepared to hold their money balances in the national currency, deregulation could...

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