| Should every country have its own currency, or should some of them adopt a common one? Political scientists, with their emphasis on sovereignty, have no doubts in their minds - to each, its own they say. But economists will be economists, and disagree. |
| Four years ago this column had written about a paper* by Alberto Alesina, Robert J Barro and Silvana Tenreyro in which they had argued that there were many countries which could be better off entering into currency unions. The issue to be decided was an old one: do the benefits outweigh the costs? If yes, have a union; if not, don't. They had pointed to the Euro, the dollarisation in Ecuador and El Salvador, and the six West African states that have created a new common currency. Others, too, are debating it. These include several Latin American countries, Saudi Arabia, UAE, Bahrain, Oman, Qatar, and Kuwait. And there are the currency board countries as well. Well, monkey see, monkey do. So it didn't come as a surprise when at the ADB Conference in Hyderabad a couple of weeks ago the question of an Asian currency union came up. The ADB thinks an Asian currency union is a good idea. |
| But, as I said, what is the point of being an economist if you don't come up with a diametrically opposite conclusion? In a recent paper**, Sebastian Edwards, a well known international finance economist, says a currency union is a very bad idea because it doesn't solve any of the problems that are sought to be solved. |
| "I find that belonging to a currency union has not lowered the probability of facing a sudden stop or a current account reversal. I also find that external shocks have been amplified in currency union countries. The degree of amplification is particularly large when compared to flexible exchange rate countries." |
| In other words, perish the thought. That seems like a rather harsh way to kiss off an idea that makes intuitive sense. After all, currency unions are supposed to spread the risk on the principle, so to speak, that planes with bigger wings stand a better chance of gliding to safety than planes with small ones. Thus currency unions are supposed to synchronise business cycles, improve factor mobility and generally deepen economic integration which reduces the likelihood of shocks. |
| Edwards was not convinced, and decided to examine the idea from the perspective of Latin America . With good reason, I suppose, because that region seems very prone to sudden stops, current account reversals, trade shocks and the capacity to absorb such shocks, the four things that engaged Edwards. His main finding is that "the (negative) effects of external crises on GDP growth have tended to be more severe in currency union countries than in countries with a currency of their own and flexible exchange rates." |
| But he also adds that his results may not be fully kosher because he has data for only three years, that too for the euro. So why jump the gun? Also, I wonder if Latin America , with its exposure to American capital is a very good place to analyse without taking into account the influence of US policies and politics. It is like examining Saturn's moons without reference to Saturn itself. Be that as it may, western economists are blissfully unaware of the very first currency union - that too on a gigantic scale - that took place - in India, where else, when it became independent and the princely states were integrated into the new Indian union. It seems to have worked exactly as expected, rather than as Edwards' analysis suggests. But why blame foreigners? What is the oversupply of Indian economists doing when it is not aping the West - both capitalist and Marxist? |
| *Optimal Currency Areas, NBER Working Paper No. 9072, July 2002 **Monetary Unions, External Shocks and Economic Performance: A Latin American Perspective, NBER Working Paper No. 12229, May 2006 |
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