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Part - V
The need to have an independent monetary policy.
The effectiveness of monetary policy in the country before.
What is the impact and consequence on the economy by the volatility of exchange rate under the flexible regime?
Therefore, the choice would be on the basis of criterias such as: -
Existence of mechanism that can reduce the need to use exchange rate as a tool to adjust macroeconomic imbalances.
The similarities of policy goals among members.
High degree of dependence economically among members.
The symmetric shocks affecting members.
Firstly, by applying Mundell's theory, factor mobility can be used to substitute for exchange rate changes and become an adjusting mechanism. Thus the cost of abandoning the exchange rate policy tool will be small to join a monetary union. Therefore, the more the labors, capital, or fiscal transfers have high degree of mobility, the higher possibility for countries to form a monetary union.
Secondly, if the policy objectives of the member countries vary widely, even though the economic structures are quite similar, it is a great challenge to maintain the fixed exchange rate and to form a monetary union. For example, when the region exists both problems of unemployment and inflation, it is the most difficult trade-off because the two cannot be solve at the same time. Therefore, countries that prefer similar policy goals are better than those diverse to form a monetary union.
Thirdly, as observed earlier, it stresses on the degree of intra-union economic interdependence. Adopting fixed exchange rate within the union brings not only the reduction of exchange rate risks and transaction costs, but also promotes the trade activities among member countries.
Finally, the economic shocks are symmetric or not to some extent represents whether the countries posses similar economic structures. When the member countries face symmetric shocks, the crisis can be handled effectively by practicing the same monetary policy. Hence, the necessity of performing independent monetary policy respectively will be much lower.
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* Contributed by -
Vipul Mittal,
First Year, MBA (Global),
IMT, Nagpur.
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