This article is the debate whether a country such as Poland, Hungary or Sweden should join the common currency or not. It introduces arguments for joining a common currency and against joining the common currency.
In addition to fiscal policies and monetary policies, the government can also influence the exchange rate of the domestic currency. The exchange rate level and the degree of exchange rate fluctuations can have significant effects on the domestic economy.
The government can let the exchange rate ‘float’, remain ‘fixed’ or even join a common currency such as Euro in the Eurozone:
- Floating Rate. The rate is determined by the private market through supply and demand. It changes constantly. If demand for a currency is low, its value will decrease (depreciation). If demand for a currency is high, its value will increase (appreciation).
- Fixed Rate. The rate is determined by the government together with the central bank and set at the certain level. To maintain the rate as the official exchange rate, the central bank buys and sells its own currency on the foreign exchange market.
- Common Currency. It is when a group of two or more independent countries share a single currency. It is also called a currency union. The largest currency union in the world is the Eurozone where 19 members share the Euro as their currency as of 2020. One of the reasons for adopting common currency is to make trading easier between countries, simplify economic activity and coordinate monetary policy.
Joining a common currency? YES!
Benefits of joining a common currency:
- Gain of foreign investments. The world economy has become increasingly dependent on overseas investment, e.g. factories, offices, etc. If the common currency is adopted, much of this foreign investment could be gained as there are fewer exchange rate risks.
- More international trade. With less risk of currency movements, it may encourage firms to engage in international trade. A common currency would stimulate business activity between the participating countries.
- Lower costs. Having different exchange rates adds considerably to the costs of firms trading overseas. Currencies have to be converted into the domestic currency and this involves a commission cost to the bank – conversion costs from one currency to another could be substantial. Also, different price lists have to be printed and frequently updated for each separate country, if common currency is not adopted. Attempts to take out the risk of dealing in different currencies by using currency contracts and hedging can be expensive as charges have to be paid to the specialist institutions involved.
- Stability of demand. Without common currency, there might be fluctuations in export prices and overseas competitiveness of countries and companies, which lead to unstable levels of demand from customers. There is no price transparency as there would be, if all sellers used the same currency.
- Certainty of costs. Without common currency, fluctuating prices of imported raw materials and components make costing of products difficult. When firms are planning to purchase goods from abroad, it is difficult to make cost comparisons because suppliers from different countries will be using different currencies and these may change from one month to another. This means the cost differences are not clear.
- Easier to calculate profit. Without common currency, there would be uncertainty over profits to be earned from trading abroad or from investing abroad. It is because both prices and costs constantly change even from one day to another.
Joining a common currency? NO!
Benefits of not joining a common currency:
- Economic independence. By not joining the common currency, the central bank of the country could keep its status as the only authority for setting interest rates. Having one rate of interest across many countries which are at different stages of economic development and at different stages in the economic cycle, might work for some economies but not for others.
- Political independence. Replacing the currency of the country with a common currency will eventually lead to common TAX policies and government spending policies throughout the whole currency zone. This will drastically reduce the independence of each government to control its fiscal policies.
- Ability to achieve own economic goals. Allowing exchange rates to float means that the government can allow the exchange rate of the domestic currency to find its own level. The government will not use economic policies to keep it at one level or another. Interest rates can therefore be adjusted to achieve other economic objectives such as lowering unemployment or slowing down inflation.
- Less risk of setting up new business strategies. Domestic businesses will need to adjust business strategies to the country remaining outside the common currency to avoid the currency fluctuation risks and currency conversion costs.
It is worth to remembers that without joining a common currency, substantial appreciation and depreciation of a domestic currency against other currencies causes industry many problems.
