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Management of a Common Currency

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  • Alessandra Casella and Jonathan Feinstein.

Abstract

This paper presents a simple general equilibrium model of two countries using a common currency. The goal is to study how the monetary arrangement influences the optimum financing of a public good. If the two countries are allowed to print the common currency autonomously, they will finance their fiscal spending with money, oversupplying the public good and crowding out the private sector. The possibility to export part of the inflation creates a distortion in incentives such the resulting equilibrium is strictly welfare inferior to the one prevailing under flexible exchange rates. If the management of the common currency is deferred to an international central bank, each country will try to use domestic policy variables (taxes) to manipulate in its favor the actions of the bank. With no independent domestic taxes, the bank can improve welfare. However, its policies naturally support the larger country, and to induce the smaller one to participate requires giving it a disproportionately large, politically unrealistic, representation in the bank's objective function.

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Bibliographic Info

Paper provided by University of California at Berkeley in its series Economics Working Papers with number 8891.

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Date of creation: 01 Sep 1988
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Handle: RePEc:ucb:calbwp:8891

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References

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  1. Patrick J. Kehoe, 1986. "Coordination of fiscal policies in a world economy," Staff Report 98, Federal Reserve Bank of Minneapolis.
  2. Bernheim, B Douglas & Whinston, Michael D, 1986. "Common Agency," Econometrica, Econometric Society, vol. 54(4), pages 923-42, July.
  3. Helpman, Elhanan, 1981. "An Exploration in the Theory of Exchange-Rate Regimes," Scholarly Articles 3445091, Harvard University Department of Economics.
  4. Hamada, Koichi, 1976. "A Strategic Analysis of Monetary Interdependence," Journal of Political Economy, University of Chicago Press, vol. 84(4), pages 677-700, August.
  5. Helpman, Elhanan & Razin, Assaf, 1982. "Dynamics of a Floating Exchange Rate Regime," Scholarly Articles 3445095, Harvard University Department of Economics.
  6. Alberto Alesina, 1987. "A Positive Theory of Fiscal Deficits and Government Debt in a Democracy," UCLA Economics Working Papers 435, UCLA Department of Economics.
  7. 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.
  8. Wood, Geoffrey E., 1986. "European monetary integration? A review essay," Journal of Monetary Economics, Elsevier, vol. 18(3), pages 329-336, November.
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Citations

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Cited by:
  1. Cooper, R. & Kempf, H., 2000. "Establishing a Monetary Union," Papiers d'Economie Mathématique et Applications 2000.28, Université Panthéon-Sorbonne (Paris 1).
  2. Casella, Alessandra, 1990. "Participation in a Currency Union," CEPR Discussion Papers 395, C.E.P.R. Discussion Papers.
  3. Richard Pomfret, 2003. "Formation and Dissolution of Monetary Unions: Evidence from Europe, and Lessons for Elsewhere," School of Economics Working Papers 2003-03, University of Adelaide, School of Economics.
  4. Eichengreen, Barry, 1991. "Designing a Central Bank for Europe: A Cautionary Tale from the Early Years of the Federal Reserve System," CEPR Discussion Papers 585, C.E.P.R. Discussion Papers.
  5. Patrick Artus, 1992. "Passage à l'union économique et monétaire en Europe : effets sur la croissance et les politiques budgétaires," Économie et Prévision, Programme National Persée, vol. 106(5), pages 123-137.
  6. Dominique Hachette & Fernando Ossa & Francisco Rosende, 1996. "Aspectos Monetarios y Macroeconómicos de la Integración," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 33(98), pages 153-183.
  7. Guillaume Cheikbossian, 2001. "When a Monetary Union Fails: A Parable," Open Economies Review, Springer, vol. 12(2), pages 181-195, April.
  8. Joshua Aizenman, 1989. "The Competitive Externalities and the Optimal Seignorage," NBER Working Papers 2937, National Bureau of Economic Research, Inc.
  9. Joshua Aizenman & Peter Isard, 1990. "Externalities, Incentives, and Economic Reforms," NBER Working Papers 3395, National Bureau of Economic Research, Inc.

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