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Asymmetric Information and Monetary Policy in Common Currency Areas

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  • Laura Bottazzi
  • Paolo Manasse

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. Suppose 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 IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 217.

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Handle: RePEc:igi:igierp:217

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  1. Cremer, H. & Marchand, M. & Pestieau, P., . "Interregional redistribution through tax surcharge," CORE Discussion Papers RP -1218, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
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  3. Andrew Atkeson & Robert E Lucas, 2010. "On Efficient Distribution with Private Information," Levine's Working Paper Archive 2179, David K. Levine.
  4. Dixit, Avinash, 2000. "A Repeated Game Model of Monetary Union," Economic Journal, Royal Economic Society, vol. 110(466), pages 759-80, October.
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  6. Bucovetsky, S. & Marchand, M. & Pestieau, P., 1998. "Tax Competition and Revelation of Preferences for Public Expenditure," Journal of Urban Economics, Elsevier, vol. 44(3), pages 367-390, November.
  7. 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.
  8. 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.
  9. Massimo Bordignon & Paolo Manasse & Guido Tabellini, . "Optimal Regional Redistribution Under Asymmetric Information," Working Papers 93, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  10. 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.
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Cited by:
  1. Paolo Manasse, 2005. "Deficit Limits, Budget Rules and Fiscal Policy," Macroeconomics 0509011, EconWPA.
  2. Philipp Maier & Beata Bierut & Robert-Paul Berben, 2003. "The role of regional information in the optimal composition of a committee," MEB Series (discontinued) 2003-08, Netherlands Central Bank, Monetary and Economic Policy Department.
  3. 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.
  4. Sánchez, Marcelo, 2008. "Monetary stabilisation in a currency union of small open economies," Working Paper Series 0927, European Central Bank.
  5. Paolo Manasse, 2007. "Deficit Limits and Fiscal Rules for Dummies," IMF Staff Papers, Palgrave Macmillan, vol. 54(3), pages 455-473, July.

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