Most of you who have been at SSU for any time at all know about Robert Mundell. He is the Canadian economist who figured out what was wrong with the world back in the 1960s and early 1970s, and who taught me as much as I could learn when I was an editor at The Wall Street Journal editorial page. It was Bob Mundell, a professor at Columbia, along with his protégé Art Laffer, who devised the system of thought I came to call "Supply-Side Economics." Most of what I have learned about economics I first learned from these two men, who essentially revived the classical economics of a bygone era and refurbished it to fit the modern world. Instead of a lecture this summer weekend at SSU, I'm going to introduce you to Mundell's website, and suggest you simply roam around in it. http://www.columbia.edu\~ram15 There are several impressive offerings, including the entire book, International Economics, which you can poke around in, but which is really meant for graduate students who have plenty of higher math under their belts. A most interesting entry is buried in a discussion about Optimal Currency Areas -- a concept Mundell originated in 1961, when he was at the International Monetary Fund, still in his 20s. The optimum currency area, he still believes, is the world. It should be the job of the United States to stitch it together. P.S. On his home page, you will find a photograph of Nicholas Mundell, Bob and Valerie's two-year-old son.
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Case for and Against Joining an OCA?
Before I list some criteria justifying a country's fixing the exchange rate to a currency area or monetary union, allow me to list some of the circumstances under which a country might decide against joining a fixed exchange rate zone or a currency union:
(1) because the country wants a rate of inflation different from the currency area inflation rate;
(2) because the country wants to use the exchange rate as an instrument of employment policy to lower or raise wages;
(3) because the country wants to use the exchange rate as a beggar-thy-neighbor instrument to capture employment from other countries;
(4) because, as a large country, the country does not want an unfriendly country to benefit from the economies-of-size advantages of the large currency area, or else because it fears that the addition of another currency will make national macroeconomic policy more difficult;
(5) because the country wants to use the money-expansion or the "inflation tax" to finance government spending, and it could be prevented from doing so to the extent desired by the discipline of fixed exchange rates;
(6) because the country does not want to sacrifice seigniorage from the use of its money as an international means of payment; this applies especially to a large country;
(7) because the government of the country wants to use seigniorage as a source of hidden or off-budget funding for personal use by members of a corrupt dictatorship or naive democratic government;
(8) because a regime of fixed exchange rates could conflict with the required policies of a central bank that had a constitutional mandate to preserve price stability;
(9) because monetary integration with one or more other countries would remove a dimension of national sovereignty that is a vital symbol of national independence;
(10) because the country wants to optimize the currency denominations appropriate to its per capita incomes (this would be relevant only in the case of currency unions, not fixed exchange rates);
(11) because the country wants to maintain its monetary independence in order to use the money-expansion or inflation tax in the event of a war;
(12) because the country wants to protect the secrecy of its statistics, as in the case when the Soviet Union opted out of the IMF and forced its Eastern European satellites to leave the Fund;
(13) because there is no domestic political and economic leadership capable of maintaining a fixed exchange rate system in equilibrium;
(14) because the political authorities cannot achieve budget balance and/or establish confidence in the permanence of budgetary equilibrium or the viability of fixed exchange rates;
(15) because the partners in the prospective currency area are politically unstable or prone to invasion by aggressor countries;
(16) because the partner countries are poorer and will expect, aid, "equalization payments," or otherwise an unduly large proportion of the OCA's expenditures;
(17) because the country does not want to accept the degree of integration implied by the OCA agreement, such as common standards, immigration, labor or tax legislation.
So much for the case against joining an OCA. The following are some of the reasons why a country might instead choose to join an OCA:
(1) to gain the inflation rate of the OCA;
(2) to reduce transactions costs in its trade with a major partner;
(3) to eliminate the cost of printing and maintaining a separate national currency;
(4) to participate in a purchasing power parity area, which would be fostered by fixed exchange rates and even more by monetary union;
(5) to establish an anchor for policy, a fixed point around which expectations can be formulated and policies can revolve;
(6) to remove discretion from monetary and fiscal policy authorities;
(7) to keep the exchange rate from being kicked around as a political football by vested interests that want depreciation to increase profits, or to bail out debtors;
(8) to establish an automatic mechanism that will enforce monetary and fiscal discipline;
(9) to have a multinational cushion against shocks;
(10) to participate more fully and on more equal terms in the financial center and capital market of the union;
(11) to provide a catalyst for political alliance or integration;
(12) to establish a power bloc as a countervailing influence against domination of neighboring powers;
(13) to share in the political decision of determining the OCA's inflation rate;
(14) to establish a competing international currency as a rival to the dollar and earn, instead of pay, seigniorage;
(15) to reinforce or establish an economic power bloc that will have more clout in international economic discussions and have a greater power to improve, by its trade policy, its terms of trade;
(16) to delegate to a mechanism outside the domestic political process the enforcement of monetary and fiscal discipline;
(17) to participate in a restoration of a reformed international monetary system.
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We of course would love to help build a reformed international monetary system, as soon as possible, so that Nicholas Mundell can grow up in a better world.