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Monetary policy and the financial accelerator in a monetary union

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  • Kempf, Hubert
  • Gilchrist, Simon
  • Hairault, Jean-Olivier

Abstract

In this paper, we consider the effect of a monetary union in a model with a significant role for financial market imperfections. We do so by introducing a financial accelerator into a stochastic general equilibrium model of a two country economy. We show that financial market imperfections introduce important cross-countryt transmission mechanisms to asymmetric shocks to supply and demand. Within this framework, we study the likely costs and benefits of monetary union. We also consider the effects of cross-country heterogeneity in financial markets. Both the presence of financial frictions and the use of a single currency have significant impacts on the international propagation of exogenous shocks. The introduction of asymmetries in the financial contract widens the differences in cyclical behavior of national economies in a monetary union, but financial integration compensates the loss of policy instruments. JEL Classification: E0, E5, F0

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 0175.

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Date of creation: Sep 2002
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Handle: RePEc:ecb:ecbwps:20020175

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  1. Stephen G. Cecchetti, 1999. "Legal Structure, Financial Structure, and the Monetary Policy Transmission Mechanism," NBER Working Papers 7151, National Bureau of Economic Research, Inc.
  2. Mark Gertler & Simon Gilchrist & Fabio M. Natalucci, 2003. "External constraints on monetary policy and the financial accelerator," BIS Working Papers 139, Bank for International Settlements.
  3. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
  4. Faia, Ester, 2001. "Stabilization policy in a two country model and the role of financial frictions," Working Paper Series 0056, European Central Bank.
  5. Anil K. Kashyap & Jeremy C. Stein, 1997. "The role of banks in monetary policy: a survey with implications for the European Monetary Union," Economic Perspectives, Federal Reserve Bank of Chicago, issue Sep, pages 2-18.
  6. Gabriele Galati & Kostas Tsatsaronis, 2001. "The impact of the euro on Europe's financial markets," BIS Working Papers 100, Bank for International Settlements.
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