A North American Monetary Union, would be an asymmetric monetary union between two Periphery Economies, Canada and Mexico, and the Core large economy, the United States. One traditional aspect of the debate on NAMU has been the cost to the Periphery of giving up the exchange rate instrument in light of possible asymmetric shocks to those economies.
The major asymmetric shocks that have been identified both theoretically and empirically are commodity price shocks to energy and other natural resource commodities. Given the differences in the structure of production and trade of the Core versus the Periphery by standard Mundell-McKinnon Optimal Currency Area theory a flexible exchange rate serves to "buffer" adverse shocks or dampen commodity booms. This is all standard.
In the Canadian debate on monetary union and the current flexible exchange rate regime what is new in term of OCA cost-benefit is the possibility that exchange rate buffering per se affects the productivity performance of the smaller economy. The substantial depreciation of the Canadian dollar during the 1990's led a number of contributors including Courchene and Harris(1999) and Grubel(2000) to hypothesize that the depreciation set up endogenous negative productivity dynamics which subsequently rationalized the behavior of the exchange rate. Thus initial misalignment led to low productivity growth which in turn contributed to a lower equilibrium real exchange rate. In Harris(2001) a two sector model was developed along the lines used in the Dutch Disease literature which emphasized New Economy productivity growth potential versus Old Economy (commodity based production) labour market rigidities.
Exchange rate buffering in which the exchange rate offset external commodity prices shocks was shown to affect the technological transition dynamics from the Old to the New Economy. Effectively exchange rate buffering reduced the reallocation of resources towards high growth sectors. When the transition was one which might be regarded as a relatively permanent transition to a new General Purpose Technology based on ICT this has the effect of reducing the growth rate for a sustained period of time. The theory can be used to rationalize the observation that despite the arrival of the New Economy in the US, during the 1990's when commodity prices were falling Canada appear to increase it's comparative advantage in traditional commodity based exports.
This line of argument however is only one which links the exchange rate and productivity. Another which has figured prominently is the exchange rate sheltering hypothesis. This is simply the idea that exchange rate depreciation offers a form of temporary protection to the traded goods industries from foreign competition. Faced with a cost advantage created by currency depreciation firms are not forced to upgrade, rationalize production, cuts costs and undertake a variety of productivity enhancing activities. Sheltering can also affect entry and exit dynamics. Small scale inefficient import competing firms face less pressure to exit given an exchange rate depreciation. In addition resources are prevented from being reallocated from low productivity marginal firms to higher productivity firms. The exchange rate sheltering idea is not new and was put forward by Porter(1990) as one possible growth trap small open economies should avoid. This position in marked contrast to a more traditional approach which emphasizes the benefits of exchange rate depreciation for growth, as discussed for example by Boltho(1998). Evidence on the relative importance of these two mechanisms for productivity growth is discussed in Harris(2001).
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