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Why Join A Currency Union? A Note On The Impact Of Beliefs On The Choice Of Monetary Policy

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  • Ravenna, Federico

Abstract

We argue that a fixed exchange rate can be an optimal choice even if a policy maker could commit to the first-best monetary policy whenever the private sector's beliefs reflect incomplete information about the policy maker's dependability. This model implies that joining a currency area may be optimal for its impact not on the behavior of the policy maker, but on the beliefs of the private sector. Monetary policies are evaluated using a new Keynesian model of a small open economy solved under imperfect policy credibility. We quantify the minimum distance between announced policy and the private sector's beliefs that is necessary for a peg to perform better than an independent monetary policy when the policy maker can commit to the first-best policy.

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  • Ravenna, Federico, 2012. "Why Join A Currency Union? A Note On The Impact Of Beliefs On The Choice Of Monetary Policy," Macroeconomic Dynamics, Cambridge University Press, vol. 16(02), pages 320-334, April.
  • Handle: RePEc:cup:macdyn:v:16:y:2012:i:02:p:320-334_00
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    1. repec:kap:compec:v:50:y:2017:i:3:d:10.1007_s10614-016-9601-4 is not listed on IDEAS
    2. Crespo-Cuaresma, Jesús & Fernández-Amador, Octavio, 2013. "Business cycle convergence in EMU: A first look at the second moment," Journal of Macroeconomics, Elsevier, vol. 37(C), pages 265-284.

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