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Inflation in open economies with complete markets

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  • Marco Celentani
  • J. Ignacio Conde-Ruiz
  • Klaus Desmet

Abstract

This paper uses an overlapping generations model to analyze monetary policy in a two-country model with asymmetric shocks. Agents insure against risk through the exchange of a complete set of real securities. Each central bank is able to commit to the contingent monetary policy rule that maximizes domestic welfare. In an attempt to improve their country's terms of trade of securities, central banks may choose to commit to costly inflation in favorable states of nature. In equilibrium the effects on the terms of trade wash out, leaving both countries worse off. Countries facing asymmetric shocks may therefore gain from monetary cooperation.

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Paper provided by FEDEA in its series Working Papers with number 2004-12.

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Handle: RePEc:fda:fdaddt:2004-12

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  1. Alberto Alesina & Robert J. Barro, 2000. "Currency Unions," NBER Working Papers 7927, National Bureau of Economic Research, Inc.
  2. Robert J. Barro & David B. Gordon, 1981. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
  3. Cooley, Thomas F & Hansen, Gary D, 1989. "The Inflation Tax in a Real Business Cycle Model," American Economic Review, American Economic Association, American Economic Association, vol. 79(4), pages 733-48, September.
  4. Giancarlo Corsetti & Paolo Pesenti, 2001. "Welfare And Macroeconomic Interdependence," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 116(2), pages 421-445, May.
  5. Robert J. Barro & David B. Gordon, 1983. "Rules, Discretion and Reputation in a Model of Monetary Policy," NBER Working Papers 1079, National Bureau of Economic Research, Inc.
  6. Marco Celentani & J. Ignacio Conde & Klaus Desmet, 2002. "Endogenous policy leads to inefficient risk sharing," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 593, Department of Economics and Business, Universitat Pompeu Fabra, revised Mar 2003.
  7. Thomas F. Cooley & Vincenzo Quadrini, 2003. "Common Currencies vs. Monetary Independence," Review of Economic Studies, Oxford University Press, Oxford University Press, vol. 70(4), pages 785-806.
  8. Stephen Ching & Michael B. Devereux, 2003. "Mundell Revisited: a Simple Approach to the Costs and Benefits of a Single Currency Area," Review of International Economics, Wiley Blackwell, Wiley Blackwell, vol. 11(4), pages 674-691, 09.
  9. Gillman, Max, 1993. "The welfare cost of inflation in a cash-in-advance economy with costly credit," Journal of Monetary Economics, Elsevier, Elsevier, vol. 31(1), pages 97-115, February.
  10. Kurz, Mordecai & Jin, Hehui & Motolese, Maurizio, 2005. "The role of expectations in economic fluctuations and the efficacy of monetary policy," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 29(11), pages 2017-2065, November.
  11. Ronald McKinnon, 2002. "Optimum currency areas and the European experience," The Economics of Transition, The European Bank for Reconstruction and Development, The European Bank for Reconstruction and Development, vol. 10(2), pages 343-364, July.
  12. Michael Magill & Martine Quinzii, 2002. "Theory of Incomplete Markets, Volume 1," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262632543, December.
  13. Stephen Ching & Michael B. Devereux, 2000. "Risk Sharing and the Theory of Optimal Currency Areas: A Re-examination of Mundell 1973," Working Papers, Hong Kong Institute for Monetary Research 082000, Hong Kong Institute for Monetary Research.
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Cited by:
  1. Simon Sosvilla-Rivero & Pedro Rodriguez, 2010. "Linkages in international stock markets: evidence from a classification procedure," Applied Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 42(16), pages 2081-2089.
  2. Timur Hulagu & Devrim Ikizler, 2010. "Effects of Monetary Unions on Inequalities (Para Birliklerinin Esitsizlikler Uzerindeki Etkileri)," Working Papers, Research and Monetary Policy Department, Central Bank of the Republic of Turkey 1014, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
  3. David M. Arseneau, 2004. "Expectation traps in a New Keynesian open economy model," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2004-45, Board of Governors of the Federal Reserve System (U.S.).

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