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On the Benefits of a Monetary Union: does it pay to be bigger?

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  • Chiara Forlati

    ()
    (Chair of International Finance, Ecole Polytechnique Federale de Lausanne (EPFL), Switzerland)

Abstract

A two area dynamic stochastic general equilibrium model is employed to investigate the welfare implications of losing monetary independence. Two policy regimes are compared: (i) in one area there is a common currency, while in the other area countries still retain their autonomous monetary policy; (ii) there are two monetary unions. When chosen by national authorities, monetary policy can stabilize optimally the effects of country-specific shocks. However, in that case, policy decisions internalize neither the spillover effects on consumers living in the same area nor their impact on the world economy. Thus the adoption of a common currency implies a trade-off between the cost of not tailoring monetary policy to single country economic conditions and the gains entailed by the improvement upon the conduct of national monetary policies. Our results show that under markup shocks and plausible calibrations, there may be welfare gains from adopting a common currency.

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Bibliographic Info

Paper provided by Center for Fiscal Policy, Swiss Federal Institute of Technology Lausanne in its series Working Papers with number 200903.

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Length: 53 pages
Date of creation: Oct 2007
Date of revision: May 2009
Handle: RePEc:cif:wpaper:200903

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Keywords: Optimal Monetary Policy; Currency Areas; Terms of Trade Externality;

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