253
using many different currencies,
since these had to be exchanged if
trade was to take place. At one
extreme, having a different
currency for every zip code in a city
would be very inefficient. On the
other hand one currency for the
entire world would be an
undesirable straitjacket on so many
diverse economies. Mundell asked
what was the most efficient point
between these two extremes.
First of all it is important to
understand why countries need
different currencies. A country
with its own currency can make
decisions about its money supply
and interest rates, and can
therefore set its monetary policy
tailored to its own domestic
economic conditions. Also, when
the exchange rates of its currency
are not fixed, the exchange rate
with its trading partners can adjust
to offset trade imbalances. Suppose
a country specializing in
agriculture is trading with a
manufacturing economy. A sudden
increase in productivity in the
manufacturing economy might
cause an excess demand for
agricultural products and an excess
supply of manufactured goods. The
manufacturing economy slips into
a balance of payments deficit,
importing more (by value) than it
exports. The deficit causes the
manufacturing country’s currency
to depreciate, making its exports
cheaper, and therefore boosting
them and restoring equilibrium.
But suppose instead that the
manufacturing economy and
the agricultural economy shared a
currency. In this case the type of
adjustment described above would
not be possible, and it might be
that separate currencies would be
more beneficial. It might also be the
case that a single economic area—
such as that constituted by themanfacturing economy—is in fact
made up of several nation-states. It
would therefore be efficient for
them to share a currency.Business cycles
Later thinking on the subject
helped clarify the conditions under
which a currency area would be
most economically viable. For a
region to be best suited to a single
currency, it would need flexible
markets for capital and labor,
allowing both to move freely in
response to market demands.
Prices and wages would, as a
result, need to be flexible, adjusting
to demand and supply changes and
signaling to mobile capital and
labor where they should move.
The different parts of the region
would also need to share broadly
similar business cycles, allowing
the shared central bank for the
single currency to act appropriately
for the whole region. There would
also need to be mechanisms for ❯❯See also: Boom and bust 78–79 ■ Comparative advantage 80–85 ■ International trade and Bretton Woods 186–87 ■
Market integration 226–31 ■ Speculation and currency devaluation 288–93
POST-WAR ECONOMICS
It hardly appears
within the realm of
political feasibility that
national currencies would
ever be abandoned in
favor of any other
arrangement...
Robert MundellA small region that crosses national
borders may benefit from a single
currency. An area may import electricity
from a power station across the border
without the costs of exchange rates.