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Monetary stabilisation in a currency union of small open economies

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Author Info
Marcelo Sánchez () (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
Abstract

This paper studies stabilisation policies in a multi-country currency union of small open economies. It abstracts from key factors favouring currency union formation, such as reduced transaction costs and enhanced credibility, which are exogenous to the factors studied here. Demand-side shocks hamper monetary union stabilisation unless members face identical output-inflation tradeoffs and their business cycles are perfectly synchronised. Under supply shocks, welfare implications from joining a currency union are less clear cut. In particular, when these shocks are common across participating countries a tradeoff arises whereby the latter benefit if they are relatively open but are at a disadvantage in case they are of small size. Monetary-fiscal interaction leads to a free rider problem, with area-wide supply shocks eliciting higher interest rate variability. Compared with the case of real wage rigidity, increased real wage flexibility mitigates the free rider problem. Higher trade union decentralisation overall favours a currency union. The present multi-country currency union setup should not be seen as an attempt at settling the sharp differences that exist in the literature. Our model could be modified in order to derive results that are valid in more realistic environments. These include the analysis of public debt considerations in the case of fiscal policies, and both institutional and (further) macroeconomic aspects in the area of wage determination. JEL Classification: E52, E58, F33, F42, E63.

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Paper provided by European Central Bank in its series Working Paper Series with number 927.

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Length: 97 pages
Date of creation: Aug 2008
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Handle: RePEc:ecb:ecbwps:20080927

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Keywords: Monetary union; stabilisation; welfare; small open economies; fi?scal policy; wage setting.;

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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Marcelo Sánchez, 2009. "National prices and wage setting in a currency union," Working Paper Series 1058, European Central Bank. [Downloadable!]
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