Economic Integration and Monetary Union (WP 99/06)

Abstract

Recent research shows that trade of goods and financial products is much greater within countries than it is between countries, even allowing for factors such as transports costs. This lack of economic integration is likely to be costly for small nations, as internal trade is much less diverse than internal trade in large nations. European countries have long argued that the adoption of a single currency is a primary means to enhance economic and social integration, and with the adoption of the euro most European countries have given up monetary independence in order to gain these benefits. This paper examines the modern literature analysing the costs and benefits of forming a monetary union. It contends that New Zealand should reassess the merits of these arguments, although it does not perform a cost benefit analysis for New Zealand, or even recommend whose currency should be preferred. It appears that the benefits of monetary independence are lower than previously thought. This is because most countries have attained low inflation, and because of new evidence that the volatility of exchange rates inherent with monetary independence may be the cause of economic shocks rather than the means of adjusting to economic shocks.

Acknowledgements

I would like to thank Sarah Box, Bob Buckle, David Galt, Lesley Haines, David Hargreaves, Gary Hawke, Jeff Huther, Jas McKenzie, Jim Rose and the participants at seminars presented at Victoria University and at the Treasury for comments on earlier drafts of this work.

Disclaimer

The consideration of monetary union is not on the Government’s agenda. Rather, in accordance with our responsibility to be at the forefront of economic thinking, and to anticipate and examine new issues, the Treasury has reviewed key academic articles on the topic. The paper is a background paper and does not provide advice, nor does it propose any particular course of action. The Treasury have chosen to publish the review given the general interest in the topic, and in order to ensure that the analysis is top quality. The views expressed are those of the author and do not necessarily reflect the views of the New Zealand Treasury. The Treasury takes no responsibility for any errors or omissions in, or for the correctness of, the information contained in these working papers.