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Deciding to enter a monetary union: The role of trade and financial linkages

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  • Lama, Ruy
  • Rabanal, Pau

Abstract

This paper evaluates the role of trade and financial linkages in the decision to enter a monetary union. We estimate a two-country DSGE model for the U.K. economy and the euro area with financial intermediaries as in Gertler and Karadi (2011). We use the model to compute the welfare trade-offs from joining the euro. We compare the gains from trade that would occur after the adoption of the euro against the costs of relinquishing monetary policy, both conventional and unconventional. We also study the effects of the changes in the corporate risk premium observed during the recent crisis. We find that in tranquil times, when the risk premium volatility is low, the net welfare gain of joining the monetary union is 2.4 percent of life-time consumption. During financial crises, when there is a sharp increase in the volatility of the risk premium, joining a monetary union would lead to a net welfare loss of 2.2 percent of life-time consumption. The welfare analysis underscores the importance of financial stability to sustain a monetary union over time.

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  • Lama, Ruy & Rabanal, Pau, 2014. "Deciding to enter a monetary union: The role of trade and financial linkages," European Economic Review, Elsevier, vol. 72(C), pages 138-165.
    • Handle: RePEc:eee:eecrev:v:72:y:2014:i:c:p:138-165
    DOI: 10.1016/j.euroecorev.2014.08.005
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    Cited by:

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    2. Lucjan T Orlowski & Anna Tsibulina, 2014. "Integration of Central and Eastern European and the Euro-Area Financial Markets: Repercussions from the Global Financial Crisis," Comparative Economic Studies, Palgrave Macmillan;Association for Comparative Economic Studies, vol. 56(3), pages 376-395, September.
    3. Petroulakis, Filippos, 2017. "Internal devaluation in currency unions: the role of trade costs and taxes," Working Paper Series 2049, European Central Bank.
    4. Lino Sau, 2015. "Debt deflation worries: a restatement," Review of Keynesian Economics, Edward Elgar Publishing, vol. 3(3), pages 279-294, July.
    5. Rabanal, Cristian, 2017. "Sincronización cíclica en los países de la ALADI/Cyclical Synchronization in ALADI´s Countries," Estudios de Economia Aplicada, Estudios de Economia Aplicada, vol. 35, pages 421-442, Mayo.
    6. Kebalo, Léleng, 2017. "Incidence de l'ouverture économique et de la libéralisation financière des pays de la Communauté Économique des États de l'Afrique de l'Ouest sur leurs activités économiques [Impact of economic ope," MPRA Paper 79442, University Library of Munich, Germany.
    7. D’Aguanno, Lucio, 2015. "Monetary Policy and Welfare in a Currency Union," The Warwick Economics Research Paper Series (TWERPS) 1082, University of Warwick, Department of Economics.
    8. Lawson, Cornelia & Soós,Sándor, 2014. "A Thematic Mobility Measure for Econometric Analysis," Department of Economics and Statistics Cognetti de Martiis LEI & BRICK - Laboratory of Economics of Innovation "Franco Momigliano", Bureau of Research in Innovation, Complexity and Knowledge, Collegio 201402, University of Turin.
    9. Liu, Shih-Fu & Hwang, Yu-Ning & Lai, Ching-Chong, 2017. "Internal imbalances in the monetary union with asymmetric openness," International Review of Economics & Finance, Elsevier, vol. 52(C), pages 380-401.
    10. Philipp Kirchner & Benjamin Schwanebeck, 2020. "Shadow banking and the design of macroprudential policy in a monetary union," MAGKS Papers on Economics 202024, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
    11. Kebalo, Léleng, 2019. "Fiscal divergence and monetary integration in West Africa: What to draw from Darvas et al. (2005)?," Economics Discussion Papers 2019-52, Kiel Institute for the World Economy (IfW Kiel).
    12. D'Aguanno, Lucio, 2015. "Monetary Policy and Welfare in a Currency Union," Economic Research Papers 270012, University of Warwick - Department of Economics.
    13. Dobronravova, Elizaveta (Добронравова, Елизавета), 2017. "Modeling the Processes of Economic and Monetary Integration [Моделирование Процессов Экономической И Валютной Интеграции]," Working Papers 031710, Russian Presidential Academy of National Economy and Public Administration.
    14. Benjamin Schwanebeck, 2017. "Unconventional Monetary Policy in a Financially Heterogeneous Monetary Union," MAGKS Papers on Economics 201741, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
    15. Skylar Brooks, 2021. "Revisiting the Monetary Sovereignty Rationale for CBDCs," Discussion Papers 2021-16, Bank of Canada.
    16. Guilherme Bandeira, 2018. "Fiscal transfers in a monetary union with sovereign risk," Working Papers 1807, Banco de España.

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    More about this item

    Keywords

    Trade costs; DSGE model; Monetary union;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles

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