Friday, July 24, 2009

Is One Currency Enough for the United States?

Marshall Auerback recently had an interesting post on California's IOUs becoming a form of money. Mark Thoma responded to that post by noting the following:

Having fifty different currencies isn't necessarily bad, there are pros and cons to having a single currency across all fifty states, i.e. to forming currency union. With a currency union, individual members lose the ability to conduct independent monetary policy - there is one money and one policy so everyone in the group gets the same treatment - but that is less costly when the the economic differences among the members of the union is small and the same policy is generally applicable...

Another way of saying that is to ask whether United States truly is an optimal currency area. This is a question I asked in a recent paper:
Is the United States best served by a single central bank conducting countercyclical monetary policy? According to the optimal currency area (OCA) criteria, the answer is yes if the various regions of the United States (1) share similar business cycles or (2) have in place flexible wages and prices, factor mobility, fiscal transfers, and diversified economies. In the former case, similar business cycles among the regions mean that a national monetary policy, which targets the aggregate business cycle, will be stabilizing for all regions. In the latter case, dissimilar business cycles among the regions make a national monetary policy destabilizing—it will be either too stimulative or too tight—for some regions unless they have in place the above listed economic shock absorbers.


Consider, for example, a region in a currency union whose economy is not well-diversified and is slowing down because of a series of negative shocks to its primary industries. If the monetary authorities in this currency union decide to tighten because the other regional economies are expanding too fast then the region slowing down needs price flexibility, labor mobility, and federal fiscal transfers in order to offset the effects of the contractionary monetary policy. If these economic shock absorbers are absent, then this region would find this tightening of monetary policy to be further destabilizing to its economy. In general, the greater the dissimilarity of a region’s business cycle with the rest of the currency union the more important these economic shock absorbers become for the region to be a successful part of an OCA.
Graphically, this understanding can be illustrated as follows (click on figure to enlarge):

So are there any regions of the United States that fall outside the dollar OCA area? I find some evidence that the rustbelt and the energybelt might have benefited from having their own currency over the period 1983-2008. What I do not show--as is the case with most OCA studies--is the (1) added transaction costs and (2) potential political economy problems that would emerge had these regions formed their own currency unions. So it is hard to know whether these regions would have on balance benefited from having monetary autonomy. You can read the paper here.


  1. Interesting. I suppose another aspect that could be considered is the privilege of being the world's reserve currency, a privilege that derives from the size of the US economy and would be lost if the currency area was smaller. That would also need to be figured into OCA calculations for the US. (Wasnt this a motive for setting up the Euro as a challenger to dollar dominance?)

  2. David,

    Thanks for the link to the paper. I do not have enough familiarity with this literature, but the paper looks interesting.

  3. "I find some evidence that the rustbelt and the energybelt may have benefited from having their own currency over the period 1983-2008."

    Perhaps you mean "might have benefited"....