IDEAS home Printed from https://ideas.repec.org/a/adr/anecst/y2013i109-110p205-233.html
   My bibliography  Save this article

On Financial Market Incompleteness, Price Stickiness, and Welfare in a Monetary Union

Author

Listed:
  • Stéphane Auray
  • Aurélien Eyquem

Abstract

The paper builds a two-country model of a monetary union with home bias and price stickiness. Incompleteness of financial asset markets is allowed. In this environment, we derive the solution for optimal behavior by the monetary policymaker and show that welfare can be higher under incomplete markets than under complete markets. The argument is a second-best one. In a monetary union with equal nominal rigidity across countries, optimal monetary policy stabilizes aggregate, union-wide inflation, but cannot fully stabilize the country-level inflation rates. Market incompleteness results in less volatility of the terms of trade because part of the adjustment goes through the current account), and hence less volatile national inflation rates. Through this channel, welfare ends up being higher under incomplete markets. These results are also robust when nominal rigidity differs across countries and when the form of the monetary policy is modified.

Suggested Citation

  • Stéphane Auray & Aurélien Eyquem, 2013. "On Financial Market Incompleteness, Price Stickiness, and Welfare in a Monetary Union," Annals of Economics and Statistics, GENES, issue 109-110, pages 205-233.
  • Handle: RePEc:adr:anecst:y:2013:i:109-110:p:205-233
    as

    Download full text from publisher

    File URL: http://www.jstor.org/stable/23646432
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Matthew B. Canzoneri & Robert E. Cumby & Behzad T. Diba, 2004. "The Cost of Nominal Inertia in NNS Models," NBER Working Papers 10889, National Bureau of Economic Research, Inc.
    2. Benigno, Pierpaolo, 2004. "Optimal monetary policy in a currency area," Journal of International Economics, Elsevier, pages 293-320.
    3. Corsetti, Giancarlo, 2006. "Openness and the case for flexible exchange rates," Research in Economics, Elsevier, pages 1-21.
    4. Faia, Ester, 2007. "Finance and international business cycles," Journal of Monetary Economics, Elsevier, vol. 54(4), pages 1018-1034, May.
    5. Schmitt-Grohe, Stephanie & Uribe, Martin, 2003. "Closing small open economy models," Journal of International Economics, Elsevier, pages 163-185.
    6. Harrigan, James, 1993. "OECD imports and trade barriers in 1983," Journal of International Economics, Elsevier, pages 91-111.
    7. Kim, Jinill & Kim, Sunghyun Henry & Levin, Andrew, 2003. "Patience, persistence, and welfare costs of incomplete markets in open economies," Journal of International Economics, Elsevier, pages 385-396.
    8. Cole, Harold L. & Obstfeld, Maurice, 1991. "Commodity trade and international risk sharing : How much do financial markets matter?," Journal of Monetary Economics, Elsevier, vol. 28(1), pages 3-24, August.
    9. Corsetti, Giancarlo, 2006. "Openness and the case for flexible exchange rates," Research in Economics, Elsevier, pages 1-21.
    10. Beetsma, Roel M.W.J. & Jensen, Henrik, 2005. "Monetary and fiscal policy interactions in a micro-founded model of a monetary union," Journal of International Economics, Elsevier, pages 320-352.
    11. Pierpaolo Benigno, 2009. "Price Stability with Imperfect Financial Integration," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(s1), pages 121-149, February.
    12. Guillermo A. Calvo, 1983. "Staggered Contracts and Exchange Rate Policy," NBER Chapters,in: Exchange Rates and International Macroeconomics, pages 235-258 National Bureau of Economic Research, Inc.
    13. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters,in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

    More about this item

    JEL classification:

    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:adr:anecst:y:2013:i:109-110:p:205-233. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Laurent Linnemer). General contact details of provider: http://edirc.repec.org/data/ensaefr.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.