Instability and trade in currency areas
We present a model of a currency area in which labor markets of country members are isolated but there is trade among these countries. When a country experiences a negative (resp. positive) shock, inflation goes down (up). This causes two effects. On the one hand the real interest rate of this country increases (decreases). On the other hand the goods produced in this country become more (less) competitive. We show that the stability of the system depends on several factors, including a large competitive effect, how inflation expectations are formed and fiscal policy. In general, stability requires a trade-off between the rationality of expectations and budget balance.
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- James Tobin, 1975.
"Keynesian Models of Recession and Depression,"
Cowles Foundation Discussion Papers
387, Cowles Foundation for Research in Economics, Yale University.
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