Journal Issue

IMF Book Forum: Can central banks be outsourced?

International Monetary Fund. External Relations Dept.
Published Date:
June 2004
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Is the traditional link between money and national sovereignty being eroded? Many economists predict that states will increasingly give up their national currencies and “outsource” monetary management to either a foreign supplier or the joint institutions of a monetary union. But Benjamin Cohen, a professor of international political economy at the University of California, Santa Barbara, contends that these predictions are wrong. An IMF Book Forum, held on May 11, featured a discussion on Cohen’s new book, The Future of Money, with Catherine Pattillo (IMF’s Research Department), Carmen Reinhart (University of Maryland), and Kathleen McNamara (Georgetown University). The IMF’s Ashoka Mody served as moderator.

The future number of currencies in the world “really does matter for us,” Cohen said, “because it bears directly on the governance of money and the management of money, which in turn is a fundamental determinant of the distribution of wealth and power in the world.” The traditional assumption is that the number of currencies is set roughly by the number of countries in the world, although there are always exceptions.

An emerging view, however, holds that because the traditional correlation between money and sovereignty is being eroded, the number of currencies will contract sharply in coming years. Many economists foresee states giving up their national currencies and either adopting a popular foreign currency, like the dollar or the euro, or joining a currency union modeled on Europe’s Economic and Monetary Union. Monetary management for many countries will no longer be national but, in effect, will be outsourced. This assumes that monetary governance will be concentrated and simplified.

The logic underlying this belief is clear. Financial globalization’s disintegration of barriers to the movement of money across countries has produced growing competition among national currencies—a process that Cohen termed the “deterritorialization of money.” According to this reasoning, less competitive currencies will be eliminated in the same way that weaker products are eliminated by stronger products in the marketplace. From the point of view of money users, who obviously want to minimize their transaction costs, the fewer the currencies, the better.

Incomplete logic

Cohen argues, however, that this “contraction contention”—albeit popular with some very prominent economists—is wrong. The correlation between money and sovereignty is indeed eroding, but the number of currencies will expand rather than contract, and he predicted monetary governance would become more diffuse and complex rather than concentrated and simplified.

Although the logic behind the contraction contention is not incorrect, Cohen said, it is incomplete. It explains only the demand side’s preference for a small number of currencies. Looking at the supply side—made up of states and the private sector—“preferences can be expected to run very much the other way,” he observed.

First, a state will resist giving up its national currency because the government derives major benefits from its existence. A national currency enables a state’s government to use its monopoly control of the money supply to supplement government revenue or to finance public spending. It provides an effective instrument for managing macroeconomic performance and means that the state is not dependent on another sovereign for command over its purchasing power and real resources. Moreover, it is a very important symbol of national identity.

Second, Cohen said, choices are much more nuanced than the contraction contention suggests. These other choices can allow for a degree of delegation of monetary authority without going to the extreme of full monetary union. In these cases, countries can choose to retain their national currencies and so preserve at least some of the benefits associated with having a national currency.

Cohen also argues that privately issued currencies can be expected to proliferate. At one level, there are local community currencies, such as the provincial currencies circulating in Argentina at the height of its recent financial crisis. In recent years, local community currencies have been growing in number, as have transactions conducted in them. Even more important has been the emergence of electronic commerce, which is producing an incentive to create viable currencies that can likewise be described as electronic. “My favorite example of this is airline miles,” he said, pointing out that they serve all the functions of money—store of value, unit of account, medium of exchange—for a network of transactors.

Applying the logic to Africa

Referring to Cohen’s earlier book, The Geography of Money, as an inspiration for her recent book written with Paul Masson, The Monetary Geography of Africa, Pattillo spoke of some of the similarities and contrasts in their work, applied specifically to Africa. For example, one similarity with Cohen’s work is the attention that Masson and Pattillo give to political economy issues in discussing monetary unions—rather than the two extremes of a discursive political approach or a very strict economic approach.

Pattillo explained how she and Masson set up a model for examining the pros and cons of monetary union projects in Africa that has traditional optimal currency area features. Their model looks at the costs associated with the loss of national monetary sovereignty due to the need to adapt to real shocks that are asymmetric to those in the broader currency union and would thus ideally be met by a country-specific monetary policy. And they look at the advantages of a monetary union, which depends on savings through reduced transaction costs, which, in turn, depend on the extent of intraregional trade—which for Africa is very low.

But in their examination of the benefits of joining a monetary union, Masson and Pattillo’s model also takes a cross-country look at differences in fiscal discipline and fiscal distortions, which tend to be related to political considerations.

“Obviously, countries that are more disciplined are not going to want to join in monetary unions with countries that are less disciplined,” Pattillo said, “because the common central bank then will have an incentive to have more of an inflation bias, and there will be less stability for this regional currency.”

Echoing some of the findings from Cohen’s work, she and Masson found that many of these African monetary union projects are not sensible when analyzed from their model’s perspective. But there may be scope for looser forms of regional monetary cooperation, she added, that would obtain some benefits of peer pressure and mutual groupings without full monetary union. Another strategy would be to build on the credibility of existing monetary unions by adding to them countries that have demonstrated their commitment and ability to deliver sound economic policies.

How could these sorts of arrangements come about? While Cohen’s book suggests that the IMF could have a role as mediator in a country’s discussions on its ideal currency regime, Pattillo wondered whether a move from IMF surveillance over exchange rate policy—already a difficult task—to the further step of surveillance over the entire currency regime would be resisted by countries on national sovereignty grounds. Although not denying that it would be asking a lot to expect countries to accept IMF direction on this much broader issue, Cohen responded that the alternative prospect of countries making decentralized decisions entirely at the national level could produce mutually inconsistent choices and, thereby, instability and volatility in monetary matters.

De jure and de facto currencies

For Reinhart, it is crucial to distinguish between de jure and de facto demand for—and use of—currencies in making predictions about the future of money. While concurring with Cohen that there likely will be many national or even provincial currencies in the future in a de jure sense, she questioned whether those currencies would, in fact, be much in demand. This is because greater capital market integration may lead to the effective use of fewer currencies, such as the euro and the dollar.

At the same time, Reinhart predicted that many developing countries will likely want to hold on to their sovereignty over the national currency—specifically their ability to depreciate against the major reserve currencies—even if a their residents prefer to hold other currencies. Forum moderator Mody suggested an analogy with the proliferation of languages, noting that, as globalization has proceeded, a few languages nevertheless have come to dominate for efficiency reasons in international commercial and other interactions, while national symbolic forces have been pushing in the other direction. The overall result has been a compromise in which only a small number of languages are used often.

Taking a sociological perspective, McNamara argued that the future of money will depend on how public and private actors view different types of money. Commenting specifically on whether the euro may come to rival the predominant status of the dollar as an international currency, she suggested thinking about currency as a social institution. If the history of currencies over time is any guide, she said, new forms of money seeking to rival the dollar’s role may “face an uphill battle,” because status tends to lag reality.

Photo credits: Denio Zara, Padraic Hughes, Eugene Salazar, and Michael Spilotro for the IMF pages 165-67; 170-72, 174,176,177, 179, and 180; and John Gibson for AFP, page 169.

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