Saturday, January 07, 2006

Local Currencies

This post of Isaac's started me thinking about money. Macroeconomic policy can really only take place at the level of a currency zone (an area sharing the same currency) becayse money and the price level are so fundamental to the macroeconomy. For example, if the Fed pursues an inflationary monetary policy to boost output, output may be boosted a lot in, say, Silicon Valley, and very little in, say, small-town Michigan. So unemployment falls nationwide, but is high in Michigan and low in Silicon Valley. It's impossible for monetary policy to differentiate between localities within the currency zone. (This is also true for fiscal policy in general. Suppose you give a million dollars to the people of a dying town in Michigan. Will this stimulate output in that town? Maybe to some small extent, but most of it will end up in towns that have active production.)

What if Michigan and Silicon Valley had different currencies? They could pursue different macroeconomic policies. Michigan could print money and inflate their economy and Silicon Valley could keep their currency stable, or whatever they wanted to do. But if you wanted to buy a computer, you would have to exchange your currency. Thus, this is a bad idea.


Blogger Isaac said...

Remember in macro all that stuff about currency zones? Do the economies fluctuate in the same way? And I forget the other relevant criteria. Probably trade. It's somewhere in the middle of Blanchard.

6:11 PM  
Blogger henry said...

Yeah, how you determine if the currency zone is optimal. Similar shocks, labor movement, something else...

6:21 PM  
Anonymous Indy said...

Isn't this kinda why the federal reserve has regional govenors?

12:56 PM  
Blogger henry said...

The Fed has regional governors but only one policy instrument (the federal funds rate.) It's impossible to target more than one objective variable with only one policy variable.

3:12 PM  

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