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Monetary union with voluntary participation

  • William Fuchs

    (Stanford University)

  • Francesco Lippi

    ()

    (Banca d'Italia)

A Monetary Union is modeled as a technology that makes a surprise policy deviation impossible but requires voluntarily participating countries to follow the same monetary policy. Within a fully dynamic context, we identify conditions under which such arrangement may dominate a coordinated system with independent national currencies. Two new results are delivered by the voluntary participation assumption. First, optimal policy is shown to respond to the agents� incentives to leave the union by tilting both current and future policy in their favor. This contrasts with the static nature of optimal policy when participation is exogenously assumed and implies that policy in the union is not exclusively guided by area-wide developments but does occasionally take account of member countries� national developments. Second we show that there might exist states of the world in which the union breaks apart, as occurred in some historical episodes. The paper thus provides a first formal analysis of the incentives behind the formation, sustainability and disruption of a Monetary Union.

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Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 512.

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Date of creation: Jul 2004
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Handle: RePEc:bdi:wptemi:td_512_04
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  1. Thorsten Koeppl, 2004. "Differentiability of the Efficient Frontier when Commitment to Risk Sharing is Limited," Working Papers 1049, Queen's University, Department of Economics.
  2. Edward J Green & Robert H Porter, 1997. "Noncooperative Collusion Under Imperfect Price Information," Levine's Working Paper Archive 1147, David K. Levine.
  3. William Fuchs & Francesco Lippi, 2004. "Monetary union with voluntary participation," Temi di discussione (Economic working papers) 512, Bank of Italy, Economic Research and International Relations Area.
  4. Kocherlakota, Narayana R, 1996. "Implications of Efficient Risk Sharing without Commitment," Review of Economic Studies, Wiley Blackwell, vol. 63(4), pages 595-609, October.
  5. Aksoy, Yunus & De Grauwe, Paul & Dewachter, Hans, 2002. "Do asymmetries matter for European monetary policy?," European Economic Review, Elsevier, vol. 46(3), pages 443-469, March.
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  10. Silvana Tenreyro & Robert J. Barro, 2002. "Economic effects of currency unions," Working Papers 02-4, Federal Reserve Bank of Boston.
  11. Leonardo Gambacorta & Paolo Emilio Mistrulli, 2003. "Bank Capital and Lending Behaviour: Empirical Evidence for Italy," Temi di discussione (Economic working papers) 486, Bank of Italy, Economic Research and International Relations Area.
  12. Heinemann, Friedrich & Huefner, Felix P., 2002. "Is the View from the Eurotower Purely European? National Divergence and ECB Interest Rate Policy," ZEW Discussion Papers 02-69, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
  13. Casella, Alessandra, 1992. "Participation in a Currency Union," American Economic Review, American Economic Association, vol. 82(4), pages 847-63, September.
  14. Thomas, Jonathan & Worrall, Tim, 1988. "Self-enforcing Wage Contracts," Review of Economic Studies, Wiley Blackwell, vol. 55(4), pages 541-54, October.
  15. Alberto Alesina & Robert J. Barro, 2002. "Currency Unions," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 409-436, May.
  16. Benjamin J. Cohen, 1993. "Beyond Emu: The Problem Of Sustainability," Economics and Politics, Wiley Blackwell, vol. 5(2), pages 187-203, 07.
  17. Avinash Dixit & Gene M. Grossman & Faruk Gul, 2000. "The Dynamics of Political Compromise," Journal of Political Economy, University of Chicago Press, vol. 108(3), pages 531-568, June.
  18. Hamada, Koichi, 1976. "A Strategic Analysis of Monetary Interdependence," Journal of Political Economy, University of Chicago Press, vol. 84(4), pages 677-700, August.
  19. Cooley, Thomas F & Quadrini, Vincenzo, 2002. "Common Currencies versus Monetary Independence," CEPR Discussion Papers 3436, C.E.P.R. Discussion Papers.
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