Economics, 3rd Edition

FISCAL POLICY AND COMMON CURRENCY AREAS

Our discussion so far has tended to centre on the loss of autonomy in monetary policy that is entailed in 

adopting a single currency among a group of countries. However, it is obvious that there is nothing in the 

adoption of a common currency that implies that members of the currency union should not still retain 

independence in fiscal policy. For instance, in our example of an asymmetric demand shock that expands 

demand in France and contracts aggregate demand in Germany, the French government could reduce 

government spending in order to offset the demand shock, while the German government could expand 

government spending. In fact, even if France and Germany did not make up an optimal currency because 

wages were sticky and labour mobility was low between the countries, national fiscal policy could, in 

principle, still be used to ameliorate the loss of monetary policy autonomy. Let’s discuss further the issue 

of fiscal policy and currency unions.