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Common Currencies versus Monetary Independence

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  • Cooley, Thomas F
  • Quadrini, Vincenzo

Abstract

We study the optimal monetary policy in a two-country open-economy model under two monetary arrangements: (a) multiple currencies controlled by independent policy-makers; (b) common currencies controlled by a centralized policy-maker. Our findings suggest that: (i) Monetary policy competition leads to higher long-term inflation and interest rates with large welfare losses; (ii) The inflation bias and the consequent losses are larger when countries are unable to commit to future policies; (iii) in both cases, the welfare losses from higher in ation dominates the welfare costs of losing the ability to react optimally to business cycle shocks. Therefore, the coordination of policies implicit in the adoption of a common currency or dollarization has positive welfare consequences.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3436.

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Date of creation: Jun 2002
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Handle: RePEc:cpr:ceprdp:3436

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Keywords: common currency; international coordination; optimal monetary policy;

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References

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Cited by:
  1. William Fuchs & Francesco Lippi, 2004. "Monetary union with voluntary participation," Temi di discussione (Economic working papers) 512, Bank of Italy, Economic Research and International Relations Area.
  2. Sánchez, Marcelo, 2008. "Monetary stabilisation in a currency union of small open economies," Working Paper Series 0927, European Central Bank.
  3. Alho, Kari, 2002. "Stabilization Inside and Outside EMU," Discussion Papers 821, The Research Institute of the Finnish Economy.

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