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Monetary policy and the financial accelerator in a monetary union

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  • Simon Gilchrist
  • Jean-Olivier Hairault
  • Hubert Kempf

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 macro model of a two country economy. We show that financial market imperfections introduce important cross-country 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 difference in cyclical behavior of national economies in a monetary union, but financial integration compensates the loss of policy instruments.

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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 750.

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Date of creation: 2002
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Handle: RePEc:fip:fedgif:750

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Keywords: International finance ; Monetary unions;

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  1. Mark Gertler & Simon Gilchrist & Fabio M. Natalucci, 2007. "External Constraints on Monetary Policy and the Financial Accelerator," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(2-3), pages 295-330, 03.
  2. Robert Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
  3. Stephen G. Cecchetti, 1999. "Legal structure, financial structure, and the monetary policy transmission mechanism," Economic Policy Review, Federal Reserve Bank of New York, issue Jul, pages 9-28.
  4. Gabriele Galati & Kostas Tsatsaronis, 2001. "The impact of the euro on Europe's financial markets," BIS Working Papers 100, Bank for International Settlements.
  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. Faia, Ester, 2001. "Stabilization policy in a two country model and the role of financial frictions," Working Paper Series 0056, European Central Bank.
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