Why do countries within an economic union harmonise monetary policies?

Countries within an economic union harmonise monetary policies to promote economic stability and facilitate trade among member states.

Harmonising monetary policies within an economic union is a strategic move aimed at promoting economic stability and facilitating trade among member states. This is achieved by aligning the monetary policies of the member countries to ensure that they are working towards the same economic goals. The harmonisation process involves synchronising interest rates, inflation targets, and exchange rates, among other monetary policy tools.

One of the main reasons for this harmonisation is to eliminate the risk of exchange rate fluctuations. In an economic union, businesses trade freely across borders without the need for currency exchange. However, if the member countries have different monetary policies, this could lead to exchange rate fluctuations, which can increase the cost of trade and create uncertainty for businesses. By harmonising monetary policies, the economic union can maintain a stable exchange rate, making it easier and more predictable for businesses to trade across borders.

Another reason for harmonising monetary policies is to prevent competitive devaluation. This is a situation where a country deliberately devalues its currency to make its exports cheaper and more attractive to foreign buyers. However, this can lead to a 'race to the bottom', where other countries also devalue their currencies to stay competitive. This can lead to economic instability and harm the overall economic health of the union. By harmonising monetary policies, the economic union can prevent competitive devaluation and promote fair competition among member states.

Harmonising monetary policies also helps to promote economic stability within the union. If one country in the union has a high inflation rate while others have low inflation rates, this can create economic imbalances and lead to financial instability. By harmonising monetary policies, the economic union can ensure that all member countries are working towards the same inflation target, helping to maintain economic stability across the union.

In conclusion, the harmonisation of monetary policies within an economic union is a crucial step towards promoting economic stability and facilitating trade among member states. It helps to eliminate the risk of exchange rate fluctuations, prevent competitive devaluation, and maintain economic stability across the union.