Past, Present and Future
Edited by Eric J. Pentecost and André Van Poeck
4. The theory of monetary union and EMU 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...
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