Economists frequently mention the idea of an Optimal Currency Area. Krugman does it. Barry Eichengreen does it. Even monetary equilibriumist Nick Rowe does it.

As I understand it, the idea is that monetary policy helps alleviate recessions. Because different one area can be in a boom and another in a bust at the same time, it is useful to have small currency areas because then you can have more finely tuned monetary policy. This pushes the currency area that maximizes benefits (the optimal currency area) smaller. The fact that arranging trade with different currencies can be more expensive and that areas can have correlated business cycles pushes the optimal currency area bigger.

If you understand monetary economics from a monetary-equilibrium perspective, this should strike you as exceedingly odd.

First, lets make some important distinctions. Lets say a “recession” is a temporary decline in the production of market goods, without specifying it’s cause. The monetary equilibrium theorists note that an a decrease in the quantity of money relative to the demand for money can cause such a temporary decline in production and has a negative effect on welfare (explanation). Any given recession might be due to monetary disequilibrium  and/or other effects.

Monetary equilibrium theory implies that relieving monetary disequilibrium by adjusting the quantity of money to reflect changes in the demand for money is welfare enhancing because it avoids price adjustment costs as well as the costs of non-equilibrium production.

However, monetary equilibrium theory does not suggest that adjusting the quantity of money to respond to (temporary or non-temporary) changes in production for reasons other that monetary disequilibrium is welfare enhancing. If production of market goods falls because of a real productivity shock, increasing the quantity to compensate increases market good production but is welfare reducing because it adds adjustment costs and moves market good production away from it’s equilibrium level.

Thus, if Optimal Currency Areas are to make sense from a monetary disequilibrium perspective, it must be that different areas in the same currency zone can have monetary disequilibrium in the opposite directions.

The major purpose of the financial system is to move money (and other assets) from those who want them relatively less to those who want them relatively more. People who want to hold money relatively more than others borrow or sell assets and vice versa.

If the financial system is not doing this, then we already have two different currencies. Monetary policy conducted in the first area doesn’t have much of an effect on the second area and vice versa. The same bills in the first area may have a totally different price than in the second area. Making these two kinds currencies more readily distinguishable (by changing the “currency area”) would only make it harder for the whole economy to come to equilibrium.