A currency union is when a group of countries (or regions) use a common currency. For example, eight European nations created the European Monetary System in 1979. This system consisted of mutually fixed exchange rates between member countries. In 2002, twelve European countries agreed to a common monetary policy, thus forming the European Economic and Monetary Union.2 One reason why countries form these systems is to lower transaction costs of cross-border trade.
A currency union or monetary union is distinguished from a full-fledged economic and monetary union, in that they involve the sharing of a common currency but without further integration between participating countries. Further integration may include the adoption of a single market in order to facilitate cross-border trade, which entails the elimination of physical and fiscal barriers between countries to free the movement of capital, labor, goods, and services in order to strengthen overall economies. Current examples of currency unions include the Euro and the CFA Franc, among others.
Another way countries unite their currency is by use of a peg. Countries commonly peg their money to the currencies of others—typically to the U.S. dollar, the euro, or sometimes the price of gold. Currency pegs create stability between trading partners and can remain in place for decades. The Hong Kong dollar has been pegged at a rate of HK$7.8 to the U.S. dollar since 1983.3 The Bahamian dollar has been pegged at parity with the greenback since 1973.4
In addition to a peg, some countries actually adopt a foreign currency. For example, the U.S. dollar is the official currency in El Salvador and Ecuador, along with the Caribbean island nations of Bonaire, Sint Eustatius and Saba.5 The Swiss franc is the official currency in both Switzerland and Lichtenstein.
There are more than 20 official currency unions, the largest of which is the euro, which is used by 19 of the 28 members of the European Union.1 Another is the CFA franc, backed by the French treasury and pegged to the euro, which is used in 14 Central and West African in addition to Comoros.6 The Eastern Caribbean Dollar is the official currency for Anguilla, Antigua and Barbuda, Dominica, Grenada, Montserrat, Saint Kitts and Nevis, Saint Lucia, and Saint Vincent and the Grenadines.