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Time Inconsistency and Free-Riding in a Monetary Union

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  • VARADARAJAN V. CHARI
  • PATRICK J. KEHOE

Abstract

In monetary unions, a time inconsistency problem in monetary policy leads to a novel type of free-rider problem in the setting of non-monetary policies. The free-rider problem leads union members to pursue lax non-monetary policies that induce the monetary authority to generate high inflation. Free-riding can be mitigated by imposing constraints on non-monetary policies. Without a time inconsistency problem, the union has no free-rider problem; then constraints on non-monetary policies are unnecessary and possibly harmful. This theory is here detailed and applied to several non-monetary policies: labor market policy, fiscal policy, and bank regulation. Copyright (c) 2008 Federal Reserve Bank of Minneapolis with Exclusive License to Print by The Ohio State University.

Suggested Citation

  • Varadarajan V. Chari & Patrick J. Kehoe, 2008. "Time Inconsistency and Free-Riding in a Monetary Union," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(7), pages 1329-1356, October.
  • Handle: RePEc:mcb:jmoncb:v:40:y:2008:i:7:p:1329-1356
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    JEL classification:

    • F3 - International Economics - - International Finance
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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