Optimal Monetary Zones: Why is there No Single World Money

This is not a normative study in political economy but a positive analysis of monetary arrangements. Since the use of a single currency markedly reduces transaction costs, the question is why a single world currency has not emerged and displaced all other means of payment. There must be costs to using a single currency that explain why dealing in a number of currencies separated by flexible exchange rates may be a second best solution.

The use of a single currency may be subject to political constraints that make it too costly for Governments to adopt. We will use a simple Coasian model, in which institutional limitations make the first best unattainable and multiple moneys preferred. We shall test whether persistent differences in levels of unemployment, inflation, real rates of exchange, and the relative size of the bail-out funds needed to avoid the lapse of a member-state explain when single monetary zones are unstable and tend to split. With a large export sector will be considered, as possible counter-examples to our model. In these instances, a country may be ready to bear the social costs that larger nations shun, with the object of containing the harm done to the foreign sector by fiscal and monetary drift.

The special case of the dollarization or "eurolization" of small economies will be considered, as possible counter-examples to our model. In these instances, a country is ready to bear the social costs that larger nations shun, with the object of correcting historical fiscal and monetary drift.

In sum, a single world currency would appear spontaneously to minimize transaction costs if such an arrangement did not increase the likelihood of unemployment, of inflation, real exchange rate dispersion, or costly rescue programs for rigid economies.