Can a unified world currency make economic operations more stable?

  If the world uses one currency, will economic operations be more stable?

     Let me start with the answer: no, the economy will not become more stable.

     This is a very interesting question. Many people take it for granted that sovereign states issue their own currencies, but few people have considered whether this is the best economic choice. Mundell's thinking on this eventually led to the theory of optimal currency areas, which also brought him a Nobel Prize in Economics. It can be seen that whether one can see the extraordinary in the ordinary and find points worth studying in things that seem to be taken for granted is also an important sign to distinguish between great people and mediocre people.

     It is obvious that a unified currency has benefits. Even an outsider to economics can see that. It reduces transaction costs, reduces the risk of exchange rate fluctuations, promotes trade, increases competition, and so on.

     But even without considering the political feasibility, a unified currency will also have costs, which not everyone can recognize. A unified currency causes a country to lose its independence in exchange rate and monetary policy, but this does not mean that it will lead to the flow of factors to developed regions as @张鑫 said. In fact, for most of the time after the establishment of the euro zone, capital flowed from core European regions such as Germany to relatively underdeveloped regions such as Greece and Spain.

     The main cost of a unified currency is the loss of exchange rate and monetary policy independence, which will greatly weaken the ability of macro policymakers to respond to asymmetric shocks. Asymmetric shocks are easy to understand, and can be simply understood literally as shocks that have different impacts on the economies of different regions.

     There are two countries, A and B. Suppose there is a sudden asymmetric shock, which leads to a decrease in demand for country A's goods, an increase in unemployment in country A, and a slowdown in economic growth. At this time, if country A uses an independent currency, it only needs to implement an easy monetary policy to devalue its currency (the currency of a certain country has just devalued...), which can expand exports and increase employment.

     But if countries A and B use a unified currency, and if this asymmetric shock has little impact on country B, or even increases demand for country B's goods, then the exchange rate and monetary policy required by country B will be completely different from those of country A. The unified currency zone consisting of countries A and B cannot respond to this asymmetric shock with a simple exchange rate and monetary policy. This is the cost of a unified currency.

     At this point, some people may ask, can't asymmetric shocks occur within a country? When different regions of a country that implements a unified currency encounter asymmetric shocks, it is also impossible to implement different exchange rates and monetary policies in different regions. How is this different from multiple countries issuing a unified currency?

     OK, when you ask this question, you no longer take it for granted that a country issues its own currency, and this question involves the fundamentals of the optimal currency area theory: what conditions should be met for a region to use a unified currency?

     Let’s take two examples to see how a country that issues a unified currency responds when it encounters an asymmetric shock. Both examples come from Krugman (2012).

     In the late 1980s, Massachusetts suffered an asymmetric shock. From 1986 to 1991, the overall unemployment rate in the United States dropped from 7% to 6.8%, while the unemployment rate in Massachusetts rose from 4.0% to 8.8%. Massachusetts certainly could not rely on its unique exchange rate and monetary policy to escape this crisis, but by 1996, the national unemployment rate in the United States had further dropped to 5.4%, while the unemployment rate in Massachusetts had further dropped to 4.6%, close to the pre-shock level.

     What happened in between? Krugman (2012) gave another set of data. In 1986, 1991, and 1996, Massachusetts’ employment accounted for 2.7%, 2.48%, and 2.43% of the U.S. national employment, respectively. In other words, the decline in Massachusetts’ unemployment rate relative to the U.S. average was largely not because it created more jobs, but because the labor force migrated to other parts of the U.S. to find jobs.

     This mechanism is the factor mobility emphasized by Mundell (1961). If factors can flow freely, then even without independent exchange rates and monetary policies, a country's economy can still quickly return to equilibrium after an asymmetric shock.

     Another example is Florida before and after the 2008 economic crisis. In 2007, before the crisis, Florida paid $136.5 billion in taxes to the federal government and received $1.4 billion in food aid from the federal government; in 2010, after the crisis, Florida paid $111.4 billion in taxes to the federal government and received $2.9 billion in unemployment benefits and $5.1 billion in food aid from the federal government. The reduction in taxes paid and the increase in unemployment benefits and food aid alone meant that Florida received an additional subsidy of more than $30 billion, which, according to Krugman (2012), is equivalent to 5% of Florida's GDP.

This is the role of a unified central government and fiscal system in the face of asymmetric shocks.

     Of course, there are other criteria for the optimal currency area. For example, the supporters of the European Union liked to emphasize close trade relations, similar production structures and synchronized economic cycles. These characteristics can naturally reduce the possibility of asymmetric shocks and thus reduce the cost of a unified currency.

     After the European debt crisis, people realized that the implicit unlimited repayment commitment of central banks with independent currency issuance rights for their own national debt and bank deposit insurance is also very important for economic stability. However, within a unified currency area, it is obviously impossible for central banks of various countries to have independent currency issuance rights.

     Whether it is the free flow of factors or a unified central finance, these are what countries in the world lack and cannot have. So if countries really unify their currencies, the economy will undoubtedly become more unstable.