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Management of a Common Currency

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  • Casella, Alessandra
  • Feinstein, Jonathan

Abstract

This paper presents a simple general equilibrium model of two countries using a common currency. The goal is to study how the monetary arrangement influences the optimum financing of a public good. If the two countries are allowed to print the common currency autonomously, they will finance their fiscal spending with money, oversupplying the public good and crowding out the private sector. The possibility to export part of the inflation creates a distortion in incentives such the resulting equilibrium is strictly welfare inferior to the one prevailing under flexible exchange rates. If the management of the common currency is deferred to an international central bank, each country will try to use domestic policy variables (taxes) to manipulate in its favor the actions of the bank. With no independent domestic taxes, the bank can improve welfare. However, its policies naturally support the larger country, and to induce the smaller one to participate requires giving it a disproportionately large, politically unrealistic, representation in the bank's objective function.

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Bibliographic Info

Paper provided by Department of Economics, Institute for Business and Economic Research, UC Berkeley in its series Department of Economics, Working Paper Series with number qt5jv1h7nt.

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Date of creation: 22 Sep 1988
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Handle: RePEc:cdl:econwp:qt5jv1h7nt

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Related research

Keywords: common currency; International Central Bank; international coordination; Social and Behavioral Sciences;

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References

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  1. Alberto Alesina & Guido Tabellini, 1987. "A Positive Theory of Fiscal Deficits and Government Debt in a Democracy," NBER Working Papers 2308, National Bureau of Economic Research, Inc.
  2. Kareken, John & Wallace, Neil, 1981. "On the Indeterminacy of Equilibrium Exchange Rates," The Quarterly Journal of Economics, MIT Press, vol. 96(2), pages 207-22, May.
  3. Helpman, Elhanan, 1981. "An Exploration in the Theory of Exchange-Rate Regimes," Scholarly Articles 3445091, Harvard University Department of Economics.
  4. Bernheim, B Douglas & Whinston, Michael D, 1986. "Common Agency," Econometrica, Econometric Society, vol. 54(4), pages 923-42, July.
  5. Helpman, Elhanan & Razin, Assaf, 1982. "Dynamics of a Floating Exchange Rate Regime," Journal of Political Economy, University of Chicago Press, vol. 90(4), pages 728-54, August.
  6. Patrick J. Kehoe, 1986. "Coordination of fiscal policies in a world economy," Staff Report 98, Federal Reserve Bank of Minneapolis.
  7. Wood, Geoffrey E., 1986. "European monetary integration? A review essay," Journal of Monetary Economics, Elsevier, vol. 18(3), pages 329-336, November.
  8. Hamada, Koichi, 1976. "A Strategic Analysis of Monetary Interdependence," Journal of Political Economy, University of Chicago Press, vol. 84(4), pages 677-700, August.
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Citations

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Cited by:
  1. Casella, Alessandra, 1992. "Participation in a Currency Union," American Economic Review, American Economic Association, vol. 82(4), pages 847-63, September.
  2. Russell Cooper & Hubert Kempf, 1998. "Establishing a Monetary Union," NBER Working Papers 6791, National Bureau of Economic Research, Inc.
  3. Patrick Artus, 1992. "Passage à l'union économique et monétaire en Europe : effets sur la croissance et les politiques budgétaires," Économie et Prévision, Programme National Persée, vol. 106(5), pages 123-137.
  4. Richard Pomfret, 2003. "Formation and Dissolution of Monetary Unions: Evidence from Europe, and Lessons for Elsewhere," School of Economics Working Papers 2003-03, University of Adelaide, School of Economics.
  5. Joshua Aizenman & Peter Isard, 1990. "Externalities, Incentives, and Economic Reforms," NBER Working Papers 3395, National Bureau of Economic Research, Inc.
  6. Guillaume Cheikbossian, 2001. "When a Monetary Union Fails: A Parable," Open Economies Review, Springer, vol. 12(2), pages 181-195, April.
  7. Joshua Aizenman, 1989. "The Competitive Externalities and the Optimal Seignorage," NBER Working Papers 2937, National Bureau of Economic Research, Inc.
  8. Dominique Hachette & Fernando Ossa & Francisco Rosende, 1996. "Aspectos Monetarios y Macroeconómicos de la Integración," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 33(98), pages 153-183.
  9. Eichengreen, Barry, 1991. "Designing a Central Bank for Europe: A Cautionary Tale from the Early Years of the Federal Reserve System," CEPR Discussion Papers 585, C.E.P.R. Discussion Papers.

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