If I understand correctly, when a state joins a monetary union it relinquishes its ability to competitively devalue/increase the money supply during downturns.

Another mechanism Governments use to work their way out of downturns is to participate in the economy themselves, for example by undertaking infrastructure projects. Does monetary union somehow limit the ability to use this lever too?


Can monetary union work without fiscal union?

Yes, and that facilitates a comparison of economies & policies.

Note that the governmental participation you outline (tending to government's prominence in an economy) is only one approach of policy making. Another, opposite approach is neoliberalism, whereby a government's role in an economy is mostly supervisory and promotes market freedom.

It is the absence of fiscal union what allows a government to make the domestic economy more competitive by lowering taxes. And in a context of monetary union, the spectrum of fiscal differences becomes more evident, which streamlines an assessment of which economies or policies are more effective. In short, the combination of monetary union and lack of fiscal union is the "best of both worlds".

for example by undertaking infrastructure projects. Does monetary union somehow limit the ability to use this lever too?

It certainly does because monetary union removes a degree of freedom: The members of a monetary union are subject to an additional constraint necessary to preserve stability of the currency they have in common.

But more important is that the constraint that ensues from a monetary union makes it more difficult for a government to go too far on policies that ultimately are detrimental or unsustainable.

  • $\begingroup$ Thank you. Am I right in asserting that a beneficial aspect of having one’s own currency is lost in a monetary union: the devaluation of a currency in a downturn makes your economy more competitive and hence helps to self correct. Is my understanding correct? $\endgroup$ – Ben Feb 10 at 0:31
  • $\begingroup$ @Ben I would not consider devaluation a beneficial aspect. Devaluation of a currency is a fake "solution" of the problem of loss or lack of competitiveness. It is also ineffective because all other economies can react by devaluating their own currencies, thereby leading to a fruitless race of who devaluates its domestic currency most aggressively. Furthermore, devaluation of currency hurts domestic savings and all other agents of an economy who have little little or nothing to do with the exportation sector. True competitiveness is attained through other means, not through devaluations. $\endgroup$ – Iñaki Viggers Feb 10 at 12:12

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