Wednesday, January 13, 2010

Currency Unions Survival Values

As is well known, a currency union survival depends on its being an “optimal currency area” (OCA), which means that a common monetary and exchange rate policy is not detrimental to growth and employment, compared to bespoke national ones. In other words, it can be durable when “one size fits all.”

David Becworth reminds us here , that it is the case if various member countries (1) share similar business cycles and/or (2) have in place flexible wages and prices, factor mobility, fiscal transfers, and diversified economies.

Applying these classic criteria to the United States various regions (states) raises the question of the optimality (or not) of the dollar zone. If not, “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.”

The punch line: the “disparate responses to U.S. monetary policy shocks suggests that some parts of the U.S. economy may not (be) part of the dollar OCA” (i.e. Optimal Currency Area).

Note, however, that the U.S. can count on “shock absorbers” that do not exist in the case of the European economies. The eurozone is thus much more vulnerable to shocks, and as a consequence, the euro is more destabilizing for its member states economies than the dollar can be for some U.S. regions.

For an early and “ex ante” analysis along these lines see my 1998 book (in French) “L’Erreur Européenne” (Grasset) and various articles on my homepage (http://jjrosa.com). For a concise and similar analysis, see the Paul Krugman post “How Many Currencies?” in yesterday’s New York Times.

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