What exactly does Monetary Union involve? A monetary union is an arrangement between participating states in which internal exchange rates are permanently fixed and with no institutional barriers to the free movement of capital or to the circulation of currencies.

This definition of monetary union still leaves open the question of whether monetary union is compatible with the existence of national currencies or whether it implies the adoption of a common currency. The Delors Committee took the latter view — Europe under EMU would use a European currency which would evolve out of the European Currency Unit (ECU). In what follows we take this as our paradigm of a monetary union.

Before going on to discuss European monetary union in detail, let me set out the main issues which need to be addressed in considering any form of monetary union. These may be summarised under the following headings

Transaction costs and exchange-rate uncertainty

As foreign travellers we are all familiar with the transaction costs involved in changing currencies. These charges made by a bank reflect the deployment of resources - personnel and equipment - as well as the opportunity costs of holding stocks of foreign exchange (i.e., the foregone interest payments). The non-trivial nature of these charges is demonstrated by the story