Choosing Monetary Arrangements for the 21st Century: Problems of a Small Economy

Abstract

The traditional monetary arrangement, in which a country uses and manages a distinct money, has several strong advantages, but countries have increasingly been adopting other arrangements: currency unions, use of another country's currency, and currency boards. Countries entering into a monetary union agree to share monetary sovereignty. But abandonment of monetary sovereignty (full or near-dollarization) implies a permanent and irrevocable outsourcing of monetary policy. A currency board also implies outsourcing of monetary policy but without the presumption that it is permanent or irrevocable. When deciding whether to share (or abandon) monetary sovereignty, a country must ask whether the political symbolism of a common money, reduced transactions costs (and increased trade), and probably better monetary management outweigh the increased cost of having to adjust without the freedom to vary the exchange rate.