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What is a Currency Union?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 26 September 2016
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Also known as a monetary union, a currency union is a situation in which two or more national entities choose to utilize the same currency. A union of this type may be structured in several different ways, from allowing the use of the currency along with use of the national currency of each participating nation, or by agreeing to change over the currency system of each nation in order to make use of a central currency in financial transactions conducted by all the member nations. A number of examples of the currency union exist today, with additional unions under consideration by different groups of countries.

There are essentially three different types of currency unions that have been or are currently being considered for use in the world today. The most basic is known as the informal union. This approach tends to be the most simplistic, in that there is a full adoption of one of the currencies issued by a member nation for use in all the countries participating in that union. One of the more common examples of this approach has to do with nations that are considered properties of the United Kingdom. In this scenario, those countries utilize the British pound sterling as their currency of choice.

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A second approach to a currency union is known as a formal union. In this scenario, the participating nations also agree to adopt a foreign currency for use in each of their nations. The difference is that the usage of that foreign currency is conducted in tandem with domestic currency currently issued in each of the member countries. A formal approach is put into place with bilateral and multilateral agreements among the member nations that help to define the terms of use for the agreed upon foreign currency, while still affirming that each nation can and will continue to make use of their own currency within their borders.

It is also possible to structure a currency union with what is known as a formal with common policy approach. This strategy involves all the countries involved in the union developing a common monetary policy that includes creating an agreed upon process for issuing a common currency for the entire union. This is different from the formal approach, in that an entirely new currency is developed for use rather than simply affirming the use of a currency type that already exists among the collective. One of the most often cited examples of this approach is the Euro, although some member nations have over time adopted this currency as their own as well as the currency of choice for the European Union.

There are a number of benefits associated with a currency union, especially in terms of simplifying trade between the member nations. The strategy can promote trade among the countries involved, which in turn helps to strengthen the economy of each nation that belongs to the union. While there are many supporters for this type of union among nations, critics also note that there are potential drawbacks to the approach, specifically the potential for unfavorable economic conditions to develop in multiple nations if the common currency should begin to experience a downturn in the foreign exchange market.

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