Formation and Dissolution of Monetary Unions: Evidence from Europe, and Lessons for Elsewhere

With the establishment of the euro, many commentators have drawn positive lessons from European monetary union for monetary integration in other parts of the world. This paper argues that the European experience of the 1990s is richer than a simple story of the inevitability of monetary integration. The dissolution of the Yugoslav, Czechoslovak and Soviet currency areas between 1991 and 1993 meant that Europe had more independent currencies in 2002 than it did in 1991. These developments are not explained by the dominant theoretical framework for analysing currency domains, ie. the optimum currency area theory originating from Mundell and McKinnon. The crucial issues concerned who determines the conduct of monetary and fiscal policy, rather than the issues emphasized in OCA theory of whether macro policy will be effective or not. A typology of countries adopting a common currency distinguishes between microstates which use another country’s currency for (private sector) transactions costs reasons, and currency unions involving larger states which are driven by (public sector) transactions arguments to do with adopting some form of common budget. Assessment of the relevance of OCA theory has implications for evaluating the prospects for monetary unions outside Europe. JEL Classifications: F33; F02; E50