Working paper No. 89
By Marion Kohler
This paper examines the link between currency unions and customs unions. The size of a bloc of countries practising some form of co-ordination of monetary policy is limited by the incentive to free-ride that formation of the bloc creates. However, when the threat of a trade war is introduced, the stable size of the bloc increases. This suggests that a) large currency areas are more likely to emerge where it combines with a customs union and b) that the stability of both currency area and customs union is closely related, as the threat of tariff penalties can enforce monetary co-operation.