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Establishing a Monetary Union

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  • Russell Cooper
  • Hubert Kempf

Abstract

This paper explores the gains to monetary union. We consider a two-country overlapping generations model. Agents work when young and have random tastes over the composition (domestic vs. foreign goods) of old age consumption. In equilibrium, governments require that local currency be used for transactions as a means of creating a base for seignorage. Thus agents hold multiple currencies to deal with uncertainty in their optimal consumption bundles. We argue that this equilibrium is Pareto dominated by a monetary union, in which there is a single currency and a strong central bank that optimally chooses zero inflation. As suggested by the European Commission's 1990 report, monetary union reduces the inefficiencies created by multiple currencies and leads to price stability. Finally, we argue this Pareto superior outcome cannot be achieved without cooperation of the two governments.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6791.

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Date of creation: Nov 1998
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Handle: RePEc:nbr:nberwo:6791

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  1. V. V. Chari & Patrick J. Kehoe, 1998. "On the need for fiscal constraints in a monetary union," Working Papers 589, Federal Reserve Bank of Minneapolis.
  2. Alessandra Casella & Jonathan Feinstein, 1988. "Management of a Common Currency," NBER Working Papers 2740, National Bureau of Economic Research, Inc.
  3. Anne Sibert, 1990. "Government finance in a common currency area," Research Working Paper 90-09, Federal Reserve Bank of Kansas City.
  4. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
  5. Robert P. Inman & Daniel L. Rubinfeld, 1997. "Rethinking Federalism," Journal of Economic Perspectives, American Economic Association, vol. 11(4), pages 43-64, Fall.
  6. Maurice Obstfeld, 1999. "Open-Economy Macroeconomics, Developments in Theory and Policy," NBER Working Papers 6319, National Bureau of Economic Research, Inc.
  7. Fischer, Stanley, 1982. "Seigniorage and the Case for a National Money," Journal of Political Economy, University of Chicago Press, vol. 90(2), pages 295-313, April.
  8. Lawrence J. Christiano & Martin Eichenbaum, 1992. "Liquidity effects and the monetary transmission mechanism," Staff Report 150, Federal Reserve Bank of Minneapolis.
  9. Canzoneri, Matthew B & Rogers, Carol Ann, 1990. "Is the European Community an Optimal Currency Area? Optimal Taxation versus the Cost of Multiple Currencies," American Economic Review, American Economic Association, vol. 80(3), pages 419-33, June.
  10. Krugman, P., 1993. "What Do We Need to Know About the International Monetary System?," Princeton Studies in International Economics 190, International Economics Section, Departement of Economics Princeton University,.
  11. Bryant, John & Wallace, Neil, 1984. "A Price Discrimination Analysis of Monetary Policy," Review of Economic Studies, Wiley Blackwell, vol. 51(2), pages 279-88, April.
  12. Wyplosz, Charles, 1997. "EMU: Why and How It Might Happen," CEPR Discussion Papers 1685, C.E.P.R. Discussion Papers.
  13. Fuerst, Timothy S., 1992. "Liquidity, loanable funds, and real activity," Journal of Monetary Economics, Elsevier, vol. 29(1), pages 3-24, February.
  14. Canzoneri, Matthew B., 1989. "Adverse incentives in the taxation of foreigners," Journal of International Economics, Elsevier, vol. 27(3-4), pages 283-297, November.
  15. Kareken, John & Wallace, Neil, 1981. "On the Indeterminacy of Equilibrium Exchange Rates," The Quarterly Journal of Economics, MIT Press, vol. 96(2), pages 207-22, May.
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Cited by:
  1. Russell W. Cooper & Hubert Kempf., 2001. "Dollarization and the conquest of hyperinflation in divided societies," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 3-12.
  2. Holod, Dmytro & Reed, Robert III, 2004. "Regional spillovers, economic growth, and the effects of economic integration," Economics Letters, Elsevier, vol. 85(1), pages 35-42, October.

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