What is a Monetary Union?

A monetary union refers to the practice of two or more sovereign countries using the same unit of currency. In other words, the countries do not have a unit of currency that is specific to their country and can be used only within that country. The benefit of a monetary union, of which the most famous recent example is the European Monetary Union, is that it eliminates exchange rates between countries using the same currency. By contrast, the downside is that any country involved loses the autonomy to make currency decisions that might be necessary to help its economy.

All societies must devise a system of currency, which is the way products are measured against each other in terms of value. It serves as the basis for transactions and is usually devised by the state, or country, itself, such as the United States dollar. There are, however, examples throughout history of different societies joining together under a common currency. When this occurs, a monetary union is formed, meaning that all of the sovereign states within are united by one currency.

In recent years, the most high-profile example was the creation of the European Monetary Union, or EMU, in 1999. The EMU established the euro as the overarching mode of currency in its member states, first in virtual form in 1999, to be followed by notes and coins issued in 2002. Those countries involved in the EMU had previously used their own individual forms of currency in the past, but they all switched to the euro for all transactions, both within their own country and with other EMU members.

The ability to trade with other member states and not have to worry about currency values is one of the prime advantages of a monetary union, which is also sometimes referred to as a currency union. For example, when the United States trades with Japan, it must worry about the value of the Japanese yen (JPY), just as Japan must be concerned with the US dollar (USD). In an arrangement like the EMU, exchange rates are unnecessary, meaning that governments within the union don't have to hedge against the decline of some foreign currency.

Autonomy over currency decisions is sacrificed when a country joins such a union, which is a crucial consideration that must be made. For example, if Italy, a member of the EMU, wanted to raise the exchange rate to help with production problems within the country, it could not do so on its own. It would have to run the problem by the entire EMU, which would then act as a group only if the other members deemed it appropriate.