Toward a Common Currency?[Note 1. This paper draws heavily on my ‘Exchange Rate Choices’, ...]

Over 100 countries have declared to the International Monetary Fund that their currencies are allowed to float against other currencies, meaning that the currency is not formally pegged to some other currency or basket of currencies. This was up from 38 in 1988, suggesting a significant move toward greater flexibility of exchange rates. Yet during the 1990s half a dozen countries installed currency boards, a particular strong form of exchange rate fixity; ten European currencies were eliminated in favor of a common currency, the euro; other countries were actively considering installing currency boards, or even adopting the US dollar for domestic use. After a quarter century of floating among the major currencies, exchange rate policy is still source of vexation, and the appropriate choice is by no means clear. Should a country allow its currency to float, subject perhaps to exchange market intervention from time to time? Or should it fix its currency to some other currency or currencies, and if so to which one(s)? Economists do not offer clearly persuasive answers to these questions. Yet for most countries, all but the largest, with the most developed domestic capital markets, the choice of exchange rate policy is probably their single most important macroeconomic policy decision, strongly influencing their freedom of action and 2 effectiveness of other macroeconomic policies, the evolution of their financial systems, and even the evolution of their economies. This paper will not answer these questions, but it will suggest that the responses that have been given by economists over the past few decades are inadequate and possibly quite poor advice to decision-makers. It goes on to suggest that in the long run the major industrialized nations-the core of the international monetary system-may find it advantageous to adopt a common currency. The choice of exchange rate regime was not always so vexing; during much of the modern era it was in practice dictated by convention, by internationally agreed rules, or by uncontrollable external circumstances. If we date the modern era from 1867, when a transAtlantic cable first linked Europe and North America electronically-connections were established within Europe from 1851, and across the Pacific in the 1870s-international monetary experience among the major countries can be divided into four distinct periods, each with fuzzy edges. The first covers the period roughly 1870-1914, during which most countries adopted a gold standard for their domestic money, implying fixed exchange rates among currencies …