Monetary Union Expansion: The Role of Market Power in Trade

Among the reasons for joining a monetary union, attention has fallen on the potential for improving a nation's monetary policy credibility. In this paper, we examine the decision problem faced by an outside country deciding whether or not to join an existing monetary union. Our analysis demonstrates that enhanced credibility stemming from differences in country characteristics along are unlikely to lead to a mutually-desirable union expansion. The intuition is that any country which finds the characteristics of the existing monetary union members relatively desirable must be relatively undesirable itself. To motivate mutually desirable entry, other potential gains must be considered. We concentrate on the fact that an outside country is likely to be quite small relative to an existing monetary union, and lack the resistance to inflation which comes with market power in trade. Consideration of this \"market power effect\" raises the potential for mutually-desirable union expansion.