chapter  13
13 Pages

The world economy and monetary policy choices

The introduction of the euro revived a debate about countries joining their economies together in ways that were beyond agreeing to fixed exchange rates. While a currency union has fixed exchange rates as its foundation, the explicit amalgamation of monetary policy differentiates a currency union from other agreements. There are also intermediate currency unions, dollarizations or euroizations of nations that simply abandon domestic currency in lieu of a major trading partner’s legal tender. Chapter 12 focused on choices facing central banks when exchange rates have the ability to adjust to new market information. A common misconception with fixed exchange rates is that foreign exchange markets are no longer market-driven. The residual effects of trade and financial flows between two countries is not seen in the official exchange rate, but pressure builds behind a fixed exchange rate due to market activity that triggers monetary reactions to alleviate that pressure.