The History of the U.S. as a Monetary Union

"So, how long did it take the United States to become an optimal currency area? Rockoff concludes that a reasonable minimum may be 150 years."

In 1788, Congress was given the exclusive right to "coin money" and "regulate the value thereof." Since then, Americans have spent and invested within the immense area of this country without ever having to worry about different exchange rates. The only exception to the monetary union occurred during the Civil War, when the nation was divided into three monetary regions.

In How Long Did It Take the United States to Become an Optimal Currency Area? (NBER Working Paper No. H124), NBER Research Associate Hugh Rockoff explores the costs and benefits of the monetary union. He notes that "the survival of the U.S. monetary union is at best muted evidence that the net effects have been positive."

The incentive for a region to join a monetary union is the minimizing of transaction costs. But the costs of uniting include giving up the exchange rate and changes in the money stock as policy tools. Whether a specific area composes an optimal currency area, or whether it would be better off as a segment of a larger monetary union, depends on the net sum of the costs and benefits. During the first 150 years of the U.S. monetary union, regional battles over monetary policy and institutions were widespread. Simply put, what was beneficial monetary policy for one region was not necessarily beneficial for another.

Rockoff finds numerous examples of regional shocks magnified by monetary reactions. The typical scenario involves a shock in financial or agricultural markets which would hit one region particularly hard. The banking system in the region would lose reserves resulting in a monetary contraction. A political battle would often erupt, and the regions that had experienced the contraction would demand a reform of the monetary system. The resulting uncertainty about the future of existing monetary institutions would further intensify the initial contraction.

In the 1930s institutional changes, such as the adoption of interregional fiscal transfers and bank deposit insurance, overcame the problem of regional banking shocks. Federally funded transfer programs, such as unemployment insurance, Social Security, and agricultural price supports, cushioned regional shocks and pumped high-powered money into regions losing reserves. Deposit insurance tended to reduce regional banking problems that characterized recessions.

So, how long did it take the United States to become an optimal currency area? Rockoff concludes that a reasonable minimum may be 150 years. It was not until the 1930s that all regions in the country could be said to be components of a single optimal currency area, the United States. Thus for a country debating whether to join a monetary union, it would be wise to examine the U.S. history first.

-- Marie A. Bussing-Burks

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