Economics, 3rd Edition

Costs of a Single Currency

The major cost to an economy in joining a common currency area relates to the fact that it gives up its 

national currency and thereby gives up its freedom to set its own monetary policy and the possibility 

of macroeconomic adjustment coming about through movements in the external value of its currency. 

Clearly, if the nations of the euro area have only one money, they can have only one monetary policy, 

which is set and implemented by the ECB. This must be the case because, since there is only one 

 currency, it’s not possible to have a different set of interest rates in different countries. Why is this a 

potential problem?

Suppose, for example, that there is a shift in consumer preferences across the common currency area 

away from goods and services produced in one country (Germany, say) and towards goods and services 

produced in another country (France, say). This situation is depicted in Figure 36.1, which shows a  leftwards 

shift in the German short-run aggregate demand curve and a rightwards shift in the French short-run 

 aggregate demand curve. What should policymakers in France and Germany do about this? One answer to 

this is, nothing: in the long run, each economy will return to its natural rate of output. In Germany, this will 

occur as the price level falls and wages, prices and perceptions adjust. In particular, as unemployment rises 

in Germany, wages eventually begin to fall. Lower wages reduce firms’ costs and so, for any given price 

level, the amount supplied will be higher. In other words, the German short-run aggregate supply curve will 

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shift to the right, until eventually it intersects with the new short-run aggregate demand curve at the natural 

rate of output. The opposite happens in France, with the short-run aggregate supply curve shifting to the 

left. The adjustment to the new equilibrium levels of output is also shown in Figure 36.1.