Return to Answer

The pros of having different currencies are that you can use monetary policy to offset shocks. Especially for trade shocks, because monetary policy can change the exchange rate of a currency to affect trade. For example if Germany and France are hit by different shocks, then they will want to conduct different monetary policies, which they can't if they share the same currency. The main cost of different currencies are transaction costs of exchange, which can hamper things trade and tourism.

The pros of having different currencies are that you can use monetary policy to offset shocks. Especially for trade shocks, because monetary policy can change the exchange rate of a currency to affect trade. For example if Germany and France are hit by different shocks, then they will want to conduct different monetary policies, which they can't if they share the same currency. The main cost of different currencies are transaction costs of exchange, which can hamper things like trade and tourism.

It is worth noting, that the pioneer in this literautre was Robert Mundell with his 1961 paper. The other two most important works are Kenen (1969) and Mckinnon (1963). The criteria are:

3. A risk sharing system, such as fiscal transfers. Since monetary policy can't be used, we would need fiscal policy. Fiscal transfers from umaffected areas can help with negaive shocks in another region. The Eurozone has a no-bailout clause, so this condition wasn't given during the Greek crisis. However, this was de facto abandoned. This is unsurprising to those familiar with the theory of OCAs.

4. Product Diversity (Kenen). Trade shocks, which monetary policy can help with, usually occur to certain industries and not the whole economy. If countries produce a variety of products, they will be less likely to suffer from large demand shocks. Hence, more diverse economies will face fewer trade fluctuations and see smaller increases of unemployment if shocks occur to one industry. This also reduces the need for monetary policy stabilization, since any given shock has a small impact on the overall economy.

It is worth noting, that the pioneer in this literature was Robert Mundell with his 1961 paper. The other two most important works are Kenen (1969) and Mckinnon (1963). The criteria are:

3. A risk sharing system, such as fiscal transfers. Since monetary policy can't be used, we would need fiscal policy. Fiscal transfers from unaffected areas can help with negative shocks in another region. The Eurozone has a no-bailout clause, so this condition wasn't given during the Greek crisis. However, this was de facto abandoned. This is unsurprising to those familiar with the theory of OCAs.

4. Product Diversity (Kenen). Trade shocks, which monetary policy can help with, usually occur to certain industries and not the whole economy. If countries produce a variety of products, they will be less likely to suffer from large demand shocks. Hence, more diverse economies will face fewer trade fluctuations and see smaller increases of unemployment if shocks occur to one industry. This also reduces the need for monetary policy stabilization, since any given shock has a small impact on the overall economy.

I will focus on some economics reasons not mentioned explicitly so far. There are economic benefits to having your own currency. Your question essentially raise the question of so-called "Optimum Currency Areas" (OCAs). There was a lot of interest in the question of what areas should have the same currency. It is in general not immediately obvious that different countries should have the same currency, or that the same country should have the same currency everywhere.

2.1. High labor mobility across regions. If there is a recession in one region and people can move to another one as a response, then monetary policy is less important in adjusting to the shock, as labor itself adjusts. This is a reason why countries can usually have the same currency. For example, people who lose their job in one U.S. state often move to another. If that wouldn't be possible, then adjusting to the recession with monetary policy would be more important. That is why the Schengen free movement agreement is so important for the Euro to be sustainable. Note that wage flexibility would be required here as well.

3. A risk sharing system, such as fiscal transfers. Since monetary policy can't be used, we would need fiscal policy. With fiscal transfers can help with negaive shocks in a region. The Eurozone has a no-bailout clause, so this condition wasn't given during the Greek crisis. However, this was de facto abandoned. This is unsurprising to those familiar with the theory of OCAs.

4. Product Diversity (Kenen). Tade shocks, which monetary policy can help with usually occur to certain industries and not the whole economy. If countrie produce a variety of products they will be less likely to suffer from large demand shocks. Hence, more diverse economies will face fewer trade fluctuations and see smaller increases of unemployment if shocks occur to one industry. This also reduces the need for monetary policy stabilization, since any given shock has a small impact on the overall economy.

I will focus on some economics reasons not mentioned explicitly so far. There are economic benefits to having your own currency. Your question essentially raises the question of so-called "Optimum Currency Areas" (OCAs). There was a lot of interest in the question of what areas should have the same currency. It is in general not immediately obvious that different countries should have the same currency, or even that the same country should have the same currency everywhere.

2.1. High labor mobility across regions. If there is a recession in one region and people can move to another one as a response, then monetary policy is less important in adjusting to the shock, as labor itself adjusts. This is a reason why countries can usually have the same currency within their whole territory. For example, people who lose their job in one U.S. state often move to another. If that wouldn't be possible, then adjusting to the recession with monetary policy would be more important. That is why the freedom of movement agreement is so important for the Euro to be sustainable. Note that wage flexibility would be required here as well.

3. A risk sharing system, such as fiscal transfers. Since monetary policy can't be used, we would need fiscal policy. Fiscal transfers from umaffected areas can help with negaive shocks in another region. The Eurozone has a no-bailout clause, so this condition wasn't given during the Greek crisis. However, this was de facto abandoned. This is unsurprising to those familiar with the theory of OCAs.

4. Product Diversity (Kenen). Trade shocks, which monetary policy can help with, usually occur to certain industries and not the whole economy. If countries produce a variety of products, they will be less likely to suffer from large demand shocks. Hence, more diverse economies will face fewer trade fluctuations and see smaller increases of unemployment if shocks occur to one industry. This also reduces the need for monetary policy stabilization, since any given shock has a small impact on the overall economy.