NationStates Jolt Archive

Today I thought about one argument I often hear against the euro (or indeed any common currency).

That argument is that a common central bank has to set interest rates according to the aggregate situation. If inflation is rising in the entire euro zone, the central bank will have to raise interest rates, even if for example the Italian economy may actually be hurt by this.

It's certainly true. It happened.

But now take the same idea to the US. As I understand it, the state of Michigan has experienced the occasional tough times over the past decade or so. At the same time, California may have been doing quite well.

Yet the Fed has set the same interest rate for both states. If the (much bigger) Californian economy was overheating and inflation rose, it had to raise interest rates - even if that slowed down the economy in Michigan even more.

Would it not make sense then to have a different interest rate therefore a different currency in both states?*

No, it would not, because the benefits of this are outweighed by the costs of having to deal with a currency exchange in cross-border trade between the two states. Or indeed between 50 states which might then have anywhere up to 50 different currencies. If we really wanted to, we might even push the concept further...how about every county getting a different currency?

*Having the same currency but two different central bank rates makes no sense because anyone with half a brain would take advantage by first borrowing in the place with low interest and then moving the money to the place with higher interest. That would kill off any attempt to modify the money supply by the central bank in question.

The Western Australian and Queensland dollar, while we're at it?

Actually I'm currently doing my dissertation on whether two distinct business cycles exist in Australia and the implications.

Perhaps, an interesting thought is that larger monetary unions have more "bite". By this I mean the sensititivity of the exchange rate to monetary policy is less in big unions, making the direct effect of interest rates more prominent and the exchange rate less unstable.

As references may I point:
Weber, E.J. (2006) Monetary Policy in a Heterogeneous Monetary Union: The Australian Experience, Applied Economics, vol 38.
and
Carlino & DeFina (1998) The differential regional effects of monetary policy, The Review of Economics and Statistics, vol.39 (American Article)

Hmmmm, Euro notes look like monopoly money. But that's no bad thing because me likes monopoly.

I see where you're coming from, but the problem with your argument is that in the US there's no language barrier whereas European countries invariably have different languages. Anyone who's willing and able to defeat the significantly greater problem raised by language isn't going to be put off by a foreign currency.

Well in the whole of the UK there are many different styles of banknote. 3 different type’s from Scotland, 4 from N.I, 1 from the Isle of Man and 1 from the Channel Islands. All of these notes run alongside the main Bank of England notes and are accepted more or less everywhere.

Anyway, surely it would be more cost effective to have a separate monetary policy per state than to have a whole new currency.

Bank notes aren't legal tender in scotland (or something like that).

I don't think that internal interest rates matter all that much in the long run. The big dislocation for california vs michigan came not from fiscal stimulus thru low interest rates (which only create asset price bubbles) but from the pressures of globalization. (The rust belt).

All that will happen in europe with a single interest rate is that areas that have monkeyed with their currency to create the illusion of competitive advantage will no longer be able to do so, and ultimately there will be a net migration of people to places that have a genuine advantage. Much like has happened with internal migrations in the US.

Anyway, this type of micro management of debt/credit cycles always ends up with the money being misallocated. Look at the US.

I see where you're coming from, but the problem with your argument is that in the US there's no language barrier whereas European countries invariably have different languages.
Well, I don't think the languages matter much when it comes to matters of monetary policy.

I've heard the argument in the OP from several people (usually Brits) who don't want to join the euro. But I don't think that this particular approach at showing the euro sucks carries any great value.

We've had state currencies before. It didn't work well at all.

The economic disadvantage that some places might suffer under a national currency is nothing compared to the cost of having to deal with 50 different currencies issued by different states with different monetary and economic situations.

We've had state currencies before. It didn't work well at all.

The economic disadvantage that some places might suffer under a national currency is nothing compared to the cost of having to deal with 50 different currencies issued by different states with different monetary and economic situations.

Yeah, but there was no "FOREX" for the states, so there was no uniform exchange rate.

That was the problem, not that there were 13ish different currencies.