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Asymmetric Information and Monetary Policy in Common Currency Areas

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  • Bottazzi, Laura
  • Manasse, Paolo

Abstract

In a Common Currency Area (CCA) the Common Central Bank sets a uniform rate of inflation across countries, taking into account the area’s economic conditions. Supposing that countries in recession favor a more expansionary policy than countries in expansion, a conflict of interest between members arises when national business cycles are not fully synchronized. If governments of member countries have an informational advantage over the state of their domestic economy, such conflict may create an adverse selection problem: national authorities overemphasize their shocks, in order to shape the common policy towards their needs. This creates an inefficiency over and above the one-policy-fits-all cost discussed in the optimal currency area literature. In order to minimize this extra-burden of asymmetric information, monetary policy must over-react to large symmetric shocks and under-react to small asymmetric ones. The result is sub-optimal volatility of inflation.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3484.

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Date of creation: Aug 2002
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Handle: RePEc:cpr:ceprdp:3484

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Keywords: asymmetric information; common currency areas; monetary policy;

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References

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  1. Andrew Atkeson & Robert E Lucas, 2010. "On Efficient Distribution with Private Information," Levine's Working Paper Archive 2179, David K. Levine.
  2. Lockwood, Ben, 1997. "Inter-Regional Insurance," Discussion Papers 9703, Exeter University, Department of Economics.
  3. Massimo Bordignon & Paolo Manasse & Guido Tabellini, . "Optimal Regional Redistribution Under Asymmetric Information," Working Papers 93, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  4. Helmuth Cremer & Maurice Marchand & Pierre Pestieau, 1996. "Interregional redistribution through tax surcharge," International Tax and Public Finance, Springer, vol. 3(2), pages 157-173, May.
  5. Bottazzi, Laura & Manasse, Paolo, 2002. "Credibility and Seigniorage in a Common Currency Area," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(4), pages 1034-46, November.
  6. Calvo, Guillermo A & Guidotti, Pablo E, 1993. "On the Flexibility of Monetary Policy: The Case of the Optimal Inflation Tax," Review of Economic Studies, Wiley Blackwell, vol. 60(3), pages 667-87, July.
  7. BUCOVETSKY, Sam & MARCHAND, Maurice & PESTIEAU, Pierre, 1997. "Tax competition and revelation of preferences for public expenditure," CORE Discussion Papers 1997003, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  8. repec:nsr:niesrd:25 is not listed on IDEAS
  9. Dixit, Avinash, 2000. "A Repeated Game Model of Monetary Union," Economic Journal, Royal Economic Society, vol. 110(466), pages 759-80, October.
  10. Horst Raff & John Wilson, 1997. "Income Redistribution with Well-Informed Local Governments," International Tax and Public Finance, Springer, vol. 4(4), pages 407-427, November.
  11. Feenstra, Robert C., 1986. "Functional equivalence between liquidity costs and the utility of money," Journal of Monetary Economics, Elsevier, vol. 17(2), pages 271-291, March.
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Cited by:
  1. Sánchez, Marcelo, 2008. "Monetary stabilisation in a currency union of small open economies," Working Paper Series 0927, European Central Bank.
  2. Paolo Manasse, 2005. "Deficit Limits, Budget Rules and Fiscal Policy," IMF Working Papers 05/120, International Monetary Fund.
  3. Paolo Manasse, 2007. "Deficit Limits and Fiscal Rules for Dummies," IMF Staff Papers, Palgrave Macmillan, vol. 54(3), pages 455-473, July.
  4. Robert-Paul Berben & Beata Bierut & Philipp Maier, 2012. "The role of regional information in the optimal composition of a committee," Economics Bulletin, AccessEcon, vol. 32(1), pages 510-517.
  5. De Grauwe, Paul & Senegas, Marc-Alexandre, 2006. "Monetary policy design and transmission asymmetry in EMU: Does uncertainty matter?," European Journal of Political Economy, Elsevier, vol. 22(4), pages 787-808, December.

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