Cities and the Fetters of Nations

10 September 2010 at 3:17 pm 3 comments

| Dick Langlois |

In Cities and the Wealth of Nations, Jane Jacobs argued that currencies should be promulgated by cities not nation states. If, for example, the currency of Detroit (the cadillac, let us say) could have floated against the currency of San Francisco (the silicon) during the late 20th century, there would have been another margin (other than the movement of capital and people) on which adjustments to technological change and shifting relative prices could have taken place, perhaps making Detroit less of a disaster area. I always found this idea appealing; but, not being a monetary economist and not having heard the idea discussed within professional economics, I wondered whether I might be missing some obvious counter-argument. Recently, however, I saw an NBER Working paper by Barry Eichengreen and Peter Temin that seems to make a similar point. Called “Fetters of Gold and Paper,” it argues that the euro and the dollar-renminbi peg are fixed-exchange-rate regimes like the gold standard. Such fixed-rate regimes may lower transaction costs in good times, but they prevent necessary adjustments in bad times, potentially leading to crises. Adjustment takes place via deflation that would otherwise have taken place through exchange-rate movement.

This is essentially the Eichengreen-Temin story about the Great Depression, which (to oversimplify) isn’t really very different from the Monetarist version. The Monetarists essentially say that gold wasn’t a fetter because there was never a real gold standard; it was a badly manipulated facsimile, which the Fed mismanaged. Eichengreen and Temin acknowledge this, but apply spin so that it was the mentalité of the gold standard that caused monetary authorities to behave as they did. In any case, as Eichengreen and Temin point out, the euro is actually a much stronger version of the fetters problem, since there is no adjustment mechanism akin to gold flows, however imperfect that mechanism might have been. Moreover, countries could (and eventually did) go off the gold standard; but there is no mechanism for countries to pull out of the euro without causing a major crisis. Interestingly, they see Bretton Woods as less of a problem, since there were international adjustment mechanisms in place. Also interestingly (for two economists of a Keynesian bent), they worry at length about the federal budget deficit and the level of government spending in the face of the renminbi peg and the current-account deficit. Usually, free-market economists worry about the budget deficit but not the current-account deficit, whereas left-of-center economists worry about the current account but not the budget. The renminbi peg makes them linked problems.

Which brings us back to Jacobs. The American dollar — one currency for all 50 states — was a prime model for the euro. And a Google search brings up dozens of comparisons between California and Greece. Why should the nation-state — whether the US or Europe — be the appropriate geographical domain of a currency?

Entry filed under: - Langlois -, Bailout / Financial Crisis, Financial Markets, History of Economic and Management Thought, Public Policy / Political Economy.

More Academic Advice In Defence of L’Ancien Regime

3 Comments Add your own

  • 1. k  |  10 September 2010 at 7:43 pm

    Until 1939, in Venezuela each bank issued paper money and the government( there was no central bank) issued metal gold and silver coins. My grandfather had to sell the paper he was paid with a discount. I read the works by Mises and Hayek on the ( more or less) same subject. But still i think the cost imposed in most people by uncertainty made it unpractical and dangerous .

  • 2. Christian Zimmermann  |  10 September 2010 at 9:27 pm

    Hi Dick,

    A common currency can indeed exacerbate shocks. But this has the positive externality of forcing governments to behave, because there is no safety net. This is why countries had to satisfy the Maastricht criteria to participate in the Euro, to demonstrate they were worthy, in particular in terms of inflation and public deficits.

    Now they do not have the luxury of inflating debt away like before. Southern European countries now have to be careful, and especially Greece was not…

    View the common currency as a commitment device. Currency board are much the same, and they have been quite successful in keeping government policies in check. The only currency board that failed so far has been Argentina, which could not control its public expenses.

  • 3. Dick Langlois  |  13 September 2010 at 3:25 pm

    Thanks, Christian. Good point. But in the US, states are forbidden in principle to run deficits. Does that mean there is more argument for a common currency in Europe than in the US?

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