Monetary zone – What it is, definition and concept | 2022

A monetary zone is understood as a geographical area or a group of countries that decide to use the same currency and a unified monetary policy.

In other words, it can be said that this group of countries in a certain geographical area share a common currency and monetary policy. This decision results after carrying out an economic integration process.

Undoubtedly, this implies following a monetary policy at a uniform macroeconomic level. In order for the area to operate in a homogeneous manner. It also requires that the entire zone work under the direction of a single Central Bank.

By meeting these requirements, a single currency can be issued and the corresponding monetary policies determined. Similarly, uniform exchange rate policies must be applied. Allowing the movement of capital within the area to be easy and simple.

What is needed for a currency zone to operate?

For it to work, the following is necessary:

Let there be a monetary union

In the first place, there needs to be a monetary union issued by a Central Bank. This requires that there is an agreement between the countries that make up the monetary zone to use the same currency. This facilitates and favors the commercialization of goods and services. As well as the free mobilization of capital.

A common monetary policy

Secondly, unification must prevail in the application of the monetary policies established by the Central Bank. These policies are aimed at achieving common economic objectives for the countries that are part of the monetary zone.

Currency Zone 1
currency zone
What is needed for a currency zone to operate?

Advantages of the implementation of a monetary zone

The main advantages achieved by implementing it are:

  • There is a lower degree of uncertainty in everything related to monetary, exchange and financial transactions.
  • With the use of a common currency, transaction costs are discarded because exchange risk can be covered.
  • It facilitates and there is an increase in intraregional trade between the countries that make up the area.
  • The risk caused by the variation of interest rates in a long-term period of time is reduced.
  • There is greater price stability within the zone.
  • In general, there is greater economic stability. Since it stimulates investment processes, job creation and this allows economic growth in the entire area.

Disadvantages of implementing a currency zone

Among the disadvantages that can be observed, we find:

  • The member countries of a monetary zone cannot unilaterally modify interest rates. Because they depend on the decisions of the Central Bank that presides over the area.
  • Given the loss of competitiveness or a crisis, the Central Bank can devalue the common currency. This as an exchange rate policy measure to get out of the problem.
  • Specifically, it could cause problems in member countries such as adaptation costs. As well as the loss of autonomy to set their own monetary, fiscal and exchange rate policies.

What criteria are shared to form a monetary zone?

Some of the criteria that are shared in their training:

  • It is expected to achieve a greater commercial opening between the countries that make up the zone.
  • The ease in the mobility of production factors such as capital and labor.
  • Greater flexibility of the prices of the factors of production. The wages of the labor production factor and the interest rates paid by the capital production factor.
  • Member countries share economic risks jointly. The periods of the economic cycles that occur in the economy are similar in the economic behavior of all member countries.
Currency Zone 2
What criteria are shared to form a monetary zone?

Example of a currency zone

Undoubtedly, one of the best known examples is the euro zone or also known as the eurozone. This monetary zone is made up of 19 countries and was created on January 1, 1999.

It has three important institutions that allow it to function. These institutions are:

  • The European Central Bank: This institution is responsible for determining and establishing the monetary policies that all member countries must apply.
  • The Eurosystem: It is made up of all the central banks of all the countries that make up the euro zone and operate under the supervision of the European Central Bank. The Eurosystem forms the monetary authority within this monetary zone.
  • The European Commission: This commission functions as the political authority within said monetary zone. This commission works together with all the finance ministers of the countries that make up the euro zone.

In conclusion, it can be said that a monetary zone is a group of countries in a certain geographical area that agree to use a common currency and monetary policy. They do this by seeking to increase the efficiency and economic growth of the region. Favoring investment and job creation within the monetary zone. By facilitating the movement of the factors of production of labor and capital.

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