9 - Historical lessons

Summary

Monetary unions

The historical approach to monetary economics is valuable to the extent that it informs the study of monetary events in other time periods. In this sense the historical approach to the Fed has much to offer the modern monetary economist. Consider, for instance, the renewed interest in monetary unions as a way of coordinating policy among a pre-existing group of monetary authorities. A monetary union may be formed by (1) replacing the moneys of the authorities with a single money or (2) retaining the identity of the moneys but fixing the rate at which any one money exchanges with another. While it is natural to think of a single body directing monetary policy in the first setting, the question arises in the second setting whether decision making will be centralized or decentralized. Moreover, how does the nature of the monetary equilibrium depend on centralization versus decentralization?

The Federal Reserve System can be used as the standard of reference in evaluating the performance of a monetary union of the second type. As reviewed in earlier chapters, Rolnick and Weber (1989) have most forcefully stated the case for viewing the 12 Federal Reserve banks as comprising a monetary union: each of the 12 Federal Reserve banks issues a distinct currency which can be traded for the other Federal Reserve currencies at a fixed rate of exchange (at par). According to Rolnick and Weber, if the reserve banks operated independently, then they would be prone to over issue money. The modern Fed has been able to overcome this problem only because monetary decisions have been centralized instead of being left to the discretion of the individual reserve banks.