The Optimal Currency Area in a Liquidity Trap
AbstractOpen economy macro theory says that when a country is subject to idiosyncratic macro shocks, it should have its own currency and a flexible exchange rate. But recently in many countries policy rates have been pushed down close to the lower bound, limiting the ability of policy-makers to accommodate shocks, even in open economies with flexible exchange rates. In this paper, we show that if the zero bound constraint is binding and policy lacks an effective `forward guidance' mechanism, a flexible exchange rate system may be inferior to a single currency area, even when there are country-specific macro shocks. When monetary policy is constrained by the zero bound, under independent currencies with flexible exchange rates, the exchange rate exacerbates the impact of shocks. Remarkably, this may hold true even if only a subset of countries are constrained by the zero bound, and other countries freely adjust their interest rates. In order for a regime of multiple currencies to dominate a single currency area in a liquidity trap environment, it is necessary to have effective forward guidance in monetary policy.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19588.
Date of creation: Oct 2013
Date of revision:
Contact details of provider:
Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
Web page: http://www.nber.org
More information through EDIRC
Find related papers by JEL classification:
- F3 - International Economics - - International Finance
- F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
- F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-11-09 (All new papers)
- NEP-CBA-2013-11-09 (Central Banking)
- NEP-DGE-2013-11-09 (Dynamic General Equilibrium)
- NEP-MON-2013-11-09 (Monetary Economics)
- NEP-OPM-2013-11-09 (Open Economy Macroeconomic)
You can help add them by filling out this form.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If references are entirely missing, you can add them using this form.