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Is the United States best served by a single currency? This question is explored in this paper by looking at the regional effects of US monetary policy shocks through the perspective of the optimal currency area framework. Using monthly state-level data for the period 1983:1–2008:3, this paper finds that some regions of the United States during this time may have benefited from having their own currency

Is the United States best served by a single central bank conducting countercyclical monetary policy? According to the optimal currency area (OCA) criteria, the answer is yes if the various regions of the United States share similar business cycles or have in place flexible wages and prices, factor mobility, fiscal transfers, and diversified economies.1 In the former case, similar business cycles among the regions mean that a national monetary policy, which targets the aggregate business cycle, will be stabilizing for all regions. In the latter case, dissimilar business cycles among the regions make a national monetary policy destabilizing—it will be either too simulative or too tight—for some regions unless they have in place the above listed economic shock absorbers. Many, if not most, observers believe the United States fits these criteria and is a successful monetary union. As a result, the United States is often held up as a benchmark case of an OCA for other areas attempting to form a monetary union (Eichengreen, 1990, Bayomi and Eichengreen, 1993, Feldstein, 1997 and Bordo, 2004). But is the United States truly an OCA? The above quote implies that the Rustbelt and the Sunbelt regions of the United States may have benefited from having their own currencies and monetary policy in early-to-mid 2007. This suggestion that the United States might benefit from the use of regional currencies is consistent with Rockoff (2000) who concludes that the United States’ OCA status is tenuous at best. Other studies also raise questions about the OCA status of the United States. Owyang et al., 2005, Crone, 2005 and Crone, 2006 shows that business cycles continue to vary in non-trivial ways across US regions. Carlino and DeFina, 1998, Carlino and DeFina, 1999a, Carlino and DeFina, 1999b, Crone, 2005 and Owyang and Wall, 2006, meanwhile, find that monetary policy shocks generate large asymmetric effects across US regions. These findings imply that certain regions of the United States may fail to meet the OCA criteria. Kouparitsas (2001) examines this possibility directly and finds that three of the eight Bureau of Economic Analysis (BEA) regions are not in the dollar OCA. Looking at state employment business cycles, Partridge and Rickman (2005) similarly conclude the United States fails to meet the traditional criteria for an OCA. Far from being a closed case, then, the United States as an OCA remains an open question. This paper provides further evidence on the OCA status of the United States. It does so by taking another look at the asymmetric effects of US monetary policy shocks on state economies. Previous studies in this literature have tried to explain the asymmetric effects of such shocks by examining whether the different transmission channels of monetary policy were more prevalent in certain regions. This paper takes a different approach by explaining the asymmetric effects of monetary policy shocks by way of the OCA criteria. Specifically, it regresses the asymmetric effects against measures of the OCA criteria and uses them to construct a decision rule that determines whether certain states would have benefited from having their own currency and monetary policy. The paper also looks at the source of economic shocks in each state and whether they are dissimilar enough to justify monetary autonomy. This approach is different than Kouparitsas (2001) who uses the response of regional economies to and the relative importance of common and idiosyncratic shocks to determine the dollar OCA.2 This paper is also unique in several other ways. First, it makes use of a monthly data set of real economic activity at the state level. The use of this higher frequency data allows for a more complete picture of each state’s economic response to a monetary policy shock. Second, previous studies have been beset with the challenge of having to deflate nominal regional economic measures, but without having an appropriate deflator to do so. Using the above data and a unique modeling approach this paper is able to overcome this challenge. Third, the modeling approach used in this paper allows for a consistent monetary policy shock to be estimated across all states. This paper, then, is able to show whether each state economy responds differently in a statistically significant way from the national economy to the same monetary policy shock.3 Collectively, these innovations provide for fresh insights into whether the United States truly is an OCA. To be clear, though, this paper like most studies on the OCA only speaks to the potential gains for US regions having their own currency and does not address the issue of increased transaction costs. The remainder of the paper proceeds as follows. First, the paper reviews the previous research on the asymmetric effects of US monetary policy on regional economies. Second, this paper formally outlines the estimation strategy and then uses it to find the state-level effect of monetary policy shocks. Third, after finding that US monetary policy shocks generate asymmetric effects this paper explains this variation using measures of the OCA criteria. Fourth, the paper uses these findings to assess what states of the United States may have benefited from having their own currency. Finally, the paper concludes with a discussion of the implications from these findings.

This paper has shown that the regional asymmetric effects generated by US monetary policy over the period 1983:1 through 2008:3 can be attributed, in part, to regions of the United States being constrained by the dollar currency union and its monetary policy. These findings imply that some states may have benefited from having their own currency at this time. Two regions in particular were found to be likely beneficiaries of such monetary autonomy: the Energy Belt and the Rustbelt. The Rustbelt may have benefited over the past decade and a half from a depreciated currency coming from a looser monetary policy that would have made its manufacturing exports more competitive. Instead, it was stuck with the US dollar that until 2002 was appreciating. The Energy Belt, on the other hand, may have benefited from having a slightly tighter monetary policy. Although this paper speaks only to the potential gains of breaking up the US monetary union and not to the added transaction costs, it does imply there may be some benefit to regional monetary autonomy. A move to regional monetary policies may seem radical, but it is not something new to the United States. Between 1838 and 1860 states were able to, and in some cases did, undertake state-level monetary policy (Shambaugh, 2006).27 During the US Civil War and up through 1879 there were two currencies and thus two regional monetary policies. Yellowbacks—gold-backed dollars—circulated in the far West and Greenbacks—fiat dollars—were everywhere else (Rockoff, 2000). In 1913, the original framers of Federal Reserve designed the system so that discount lending and open market operations could be independently conducted at the district banks. The Federal Reserve System, therefore, originally allowed for monetary policy to be determined at the district level (Meltzer, 2003).28 While regional currencies in the United States presently seem unlikely, limited regional monetary autonomy could still emerge if Federal Reserve district banks were allowed more discretion in running their discount windows. Doing so would allow for regional changes in liquidity to offset national monetary policy deemed inappropriate for the regional economy.29 A final implication of this paper is that since the United States is most likely not an OCA, policies should be promoted that keep wages and output prices flexible, labor mobile, and fiscal transfers meaningful and targeted appropriately. Together, these two policies should serve to bring the United States closer to becoming a true OCA.