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Rules Versus Discretion Under Asymmetric Shocks

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  • Pasquale Foresti

    ()
    ("Magna Graecia" University of Catanzaro)

Abstract

Monetary policy design in currency unions faces more challenging scenarios like the presence of asymmetric shocks and the higher probability of time inconsistency. An evaluation of the union welfare under a monetary rule and under discretion in these circumstances is carried out. Assuming that the transmission of monetary policy is symmetric across countries, discretion is more desirable when the shocks show high variability and are symmetric. At the same time it is very important to implement a decision making process able to marginalize the influence of single countries, and therefore time inconsistency. A monetary rule is the best arrangement in the opposite scenario. A general consequence of these findings is that the best monetary institutional framework is to implement a rule with some escape clauses. Nevertheless, when shocks have high variability and are symmetric there are both negative and positive aspects for the rule and discretion, and a case by case analysis is necessary in order to decide whether the latter performs better than the former or vice versa.

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Bibliographic Info

Article provided by AccessEcon in its journal Economics Bulletin.

Volume (Year): 32 (2012)
Issue (Month): 2 ()
Pages: 1180-1190

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Handle: RePEc:ebl:ecbull:eb-12-00142

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Keywords: Monetary Union; Monetary Policy; Asymmetric Shocks; Time Inconsistency.;

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References

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  1. Barro, Robert & Alesina, Alberto, 2002. "Currency Unions," Scholarly Articles 4551795, Harvard University Department of Economics.
  2. Paul De Grauwe, 2000. "Monetary Policies in the Presence of Asymmetries," Journal of Common Market Studies, Wiley Blackwell, Wiley Blackwell, vol. 38(4), pages 593-612, November.
  3. Clarida, R. & Gali, J. & Gertler, M., 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Working Papers, C.V. Starr Center for Applied Economics, New York University 99-13, C.V. Starr Center for Applied Economics, New York University.
  4. De Grauwe, Paul, 2000. "Monetary Policies In The Presence Of Asymmetries," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2393, C.E.P.R. Discussion Papers.
  5. Lane, Philip R., 1996. "Stabilization policy in a currency union," Economics Letters, Elsevier, Elsevier, vol. 53(1), pages 53-60, October.
  6. Silvana Tenreyro & Robert J. Barro, 2002. "Economic effects of currency unions," Working Papers, Federal Reserve Bank of Boston 02-4, Federal Reserve Bank of Boston.
  7. Daniel Gros & Carsten Hefeker, 2002. "Common Monetary Policy with Asymmetric Shocks," CESifo Working Paper Series 705, CESifo Group Munich.
  8. Alesina, Alberto & Stella, Andrea, 2010. "The Politics of Monetary Policy," Handbook of Monetary Economics, Elsevier, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 18, pages 1001-1054 Elsevier.
  9. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 85(3), pages 473-91, June.
  10. Bennett T. McCallum, 1999. "Recent developments in the analysis of monetary policy rules," Review, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, issue Nov, pages 3-12.
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