ABSTRACT
Exchange rate volatility under floating tends further to encourage currency substitution particularly in countries which lie adjacent to a country with an international currency, or country group with which they have progressively liberalised trade relations. Monetary union can take the limited form of unilaterally adopting the strong international currency of a nearby country or group of countries as sole legal tender, as in Panama, or of deep financial integration on the basis of equality as in Euroland. With currencies and currency denominations then chosen so as to yield maximum liquidity service at the lowest cost, the currencies of most of the smaller countries inevitably will be destabilised by currency substitution. Certainly monetary union is the perfect cure for money demand disturbances originating in the small country, as it makes the supply of money to such a country very nearly perfectly elastic at the unionwide interest rate.
