bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

376 MONETARY ECONOMICS
13.2 The membership of monetary unions
In principle, there is no difference between the operation of monetary policy
in a single nation state such as the UK and in a monetary union consisting
of a number of nation states. In each case, a central bank operates a single
monetary policy for the whole country or group of countries. In these
times of independent central banks and the dominance of price stability as
a policy goal, the constitutions and practices of the central banks are likely
to have much in common. In no case are monetary policy decisions of the
central bank likely to suit all regions or all economic sectors. Much of the
debate over the European single currency has been of the ‘one interest rate
does not suit all’ variety — that a policy decided by the ECB in Frankfurt
might be helpful for some member states but not for others. Yet it is also
true that an increase in interest rates by the Bank of England that suits the
south east of England might not please manufacturing industry in Scotland
or Northern Ireland. A difference between the two cases only arises if it is
more likely that a central bank decision will be wrong for some parts of the
euro area or that it will do more damage to some parts of the area than is the
case for the UK. We are talking about questions of degree rather than principle.
We could, thus, express the issues at the heart of the debate through
the following questions:
• How likely is it that the interest rate set by the central bank of a monetary
union will be unsuitable for some member countries?
• How much damage is the wrong interest rate likely to do to those
economies that it does not suit?
• Are there other types of flexibility in the economy of the monetary
union that will help the disadvantaged economies to cope with the wrong
interest rate decisions?
• Are the likely costs of wrong interest rate decisions for some parts of
the area likely to outweigh the benefits expected from the single currency?
The usual theoretical approach to these questions is known as optimum currency
area theory. This seeks to determine the optimum size and composition
of a single currency area. The logic is clear. Start with a very small
single currency area. Then, as the area is enlarged, the costs increase and
the net benefits (benefits−costs) of having a single currency decline. At
some point, the benefits and the costs become equal and we have reached
the optimum size. Beyond this, it would be advantageous to retain more