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Monetary union with voluntary participation

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Author Info
William Fuchs (Stanford University)
Francesco Lippi () (Banca d'Italia)

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Abstract

A Monetary Union is modeled as a technology that makes a surprise policy deviation impossible but requires voluntarily participating countries to follow the same monetary policy. Within a fully dynamic context, we identify conditions under which such arrangement may dominate a coordinated system with independent national currencies. Two new results are delivered by the voluntary participation assumption. First, optimal policy is shown to respond to the agentsÂ’ incentives to leave the union by tilting both current and future policy in their favor. This contrasts with the static nature of optimal policy when participation is exogenously assumed and implies that policy in the union is not exclusively guided by area-wide developments but does occasionally take account of member countriesÂ’ national developments. Second we show that there might exist states of the world in which the union breaks apart, as occurred in some historical episodes. The paper thus provides a first formal analysis of the incentives behind the formation, sustainability and disruption of a Monetary Union.

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File URL: http://www.bancaditalia.it/pubblicazioni/econo/temidi/td04/td512_04/td512/tema_512.pdf
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Paper provided by Bank of Italy, Economic Research Department in its series Temi di discussione (Economic working papers) with number 512.

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Date of creation: Jul 2004
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Handle: RePEc:bdi:wptemi:td_512_04

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Related research
Keywords: monetary union; limited commitment;

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Find related papers by JEL classification:
C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory
E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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  3. Kocherlakota, Narayana R, 1996. "Implications of Efficient Risk Sharing without Commitment," Review of Economic Studies, Blackwell Publishing, vol. 63(4), pages 595-609, October. [Downloadable!] (restricted)
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  6. Casella, Alessandra, 1992. "Participation in a Currency Union," American Economic Review, American Economic Association, vol. 82(4), pages 847-63, September. [Downloadable!] (restricted)
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  13. Green, Edward J & Porter, Robert H, 1984. "Noncooperative Collusion under Imperfect Price Information," Econometrica, Econometric Society, vol. 52(1), pages 87-100, January. [Downloadable!] (restricted)
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  14. Thorsten Koeppl, 2004. "Differentiability of the Efficient Frontier when Commitment to Risk Sharing is Limited," Working Papers 1049, Queen's University, Department of Economics. [Downloadable!]
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