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Part - IV

Firstly, the risk of the exchange rate volatility gets completely eliminated within the monetary union. Secondly, the transaction costs accompanied by the exchange of currencies will obviously reduce. This will result in promoting the trade and investment among countries and allocate the resources optimally. Consequently, it enhances the benefits of all members in the monetary union. Moreover, monetary union has several other attractions. First, it would eliminate currency transaction costs, thus enabling firms to conduct business much more efficiently. Additionally, regional price transparency would spur competition, leading to productivity gains. Most importantly, convenience and stability would promote trade and investment in the region. Tourism, a key industry for many Southeast Asian countries, also would get a boost.

On the other hand, the major cost of joining a monetary union is to give up using the independent monetary policy. This represents an autonomy will lose the ability needed to achieve equilibrium of full employment, price stability, and current account balance. Therefore, the price of joining a monetary union is not only the abandonment of adjusting exchange rate ability but the loss of power of executing independent monetary policy. The last is the most difficult one and will pay the highest cost to autonomy. P. Krugman (1990) used the costs and benefits method to analyze joining a monetary union. He argued that the net benefits of joining a monetary union would increase with the dependence of the intra-union trade (Figure 1).

The costs of joining a monetary union will decrease with the increase of intra-union trade. On the time front, the benefits of joining a monetary union will enhance with the degree of dependence on intra-union trade increase. The reason of the former is the increase of the degree of dependence on intra-union trade will make the necessity of performing an independent exchange rate policy smaller. The later reflects the reduction in transaction costs and exchange rate risks.

Conceptually, a monetary union is formed by countries adopting fixed exchange rate regime among themselves, while using flexible exchange rate for outside the union. Hence, before making the decision one country must consider thoroughly if she herself is suitable for fixed or flexible exchange rate. These depend on three major choices: -

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* Contributed by -
Vipul Mittal,
First Year, MBA (Global),
IMT, Nagpur.