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Monetary Cohabitation in Europe

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  • Torsten Persson
  • Guido Tabellini

Abstract

How can monetary policy in stage III of European Monetary Union be coordinated between the `ins' and the `outs'? This paper compares alternative institutional mechanisms, and concludes that a generalized system of inflation targets at the European level has several merits. It strengthens domestic credibility of monetary policy. It rules out deliberate attempts to gain competitiveness through devaluations. It forces monetary policy to respond automatically to various macroeconomic shocks which is stabilizing for the real exchange rate. It distributes these shocks symmetrically across countries. On the basis of a simple theoretical model of policy coordination, the paper shows that a system of inflation targets approximates an optimal policy of international cooperation. Preliminary empirical evidence supports these theoretical results.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5532.

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Date of creation: Apr 1996
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Publication status: published as American Economic Review, Vol. 86, no. 2 (May 1996): 111-116.
Handle: RePEc:nbr:nberwo:5532

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  1. Canzoneri, Matthew B & Gray, Jo Anna, 1985. "Monetary Policy Games and the Consequences of Non-cooperative Behavior," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 26(3), pages 547-64, October.
  2. Obstfeld, Maurice, 1991. "Destabilizing Effects of Exchange-Rate Escape Clauses," CEPR Discussion Papers 518, C.E.P.R. Discussion Papers.
  3. Canzoneri, Matthew B. & Henderson, Dale W., 1988. "Is sovereign policymaking bad?," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 28(1), pages 93-140, January.
  4. Alesina, Alberto F & Grilli, Vittorio, 1991. "The European Central Bank: Reshaping Monetary Politics in Europe," CEPR Discussion Papers 563, C.E.P.R. Discussion Papers.
  5. Martin, Philippe, 1995. "Free-riding, convergence and two-speed monetary unification in Europe," European Economic Review, Elsevier, vol. 39(7), pages 1345-1364, August.
  6. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March.
  7. Persson, Torsten & Tabellini, Guido, 1995. "Double-edged incentives: Institutions and policy coordination," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 38, pages 1973-2030 Elsevier.
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