Stability of Monetary Unions: Lessons from the Break-Up of Czechoslovakia

In 1993, Czechoslovakia experienced a two-fold break-up: On January 1st, the country disintegrated as a political union, while preserving an economic and monetary union. Then, the Czech-Slovak monetary union collapsed on February 8th. We analyze the economic background of the two break-ups, and discuss lessons for stability of monetary unions in general. We argue that while Czechoslovakia could be considered an optimum currency area, it was in fact less integrated than some other existing unions. That, along with low labor mobility and higher concentration of heavy and military industries in Slovakia, made Czechoslovak economy vulnerable to asymmetric economic shocks – such as those induced by the economic transition. Furthermore, the Czech- Slovak monetary union was marred by low credibility, lack of political commitment, low exit costs, and the absence of fiscal transfers.