INTRODUCTION

The two strong forms of monetary integration discussed in the previous chapter, forming a full-fledged monetary union and adopting formally another country's currency, are often described as currency consolidation. That is because they involve a reduction in the number of national currencies. The two arrangements, however, differ in their answers to a fundamental question: Who makes monetary policy? A monetary union assigns that task to a single central bank with shared decision making; de jure dollarization assigns it to a foreign central bank – the one that issues the currency replacing the national currency.

Early analytic work on currency consolidation did not even ask this question. It dealt with a rudimentary arrangement, a simple currency union, that bypassed the question completely. We will soon see, however, why we must answer the question when comparing a monetary union and unilateral dollarization.

This chapter, however, has a larger purpose. It surveys the potential benefits and costs of currency consolidation. Does currency consolidation stimulate trade between the two or more countries involved? Does it reduce its members' vulnerability to financial crises? Does it raise or reduce the economic costs of adjusting to various shocks, including both domestic and external shocks?

These are important questions. They can help us assess the strength of the case for EMU, discussed in the next chapter, as well as the actual economic performance of its member countries.