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External trade and monetary policy in a currency area

Author

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  • Martina Cecioni

    (Bank of Italy, Economics, Research and International Relations)

Abstract

For historical and geographical reasons, the member countries of the European Monetary Union (EMU) display different degrees of external trade openness. The paper lays out a model for a currency area composed of two regions. One region is more open to trade with a third country outside the area than the other. Using the utility-based loss function for the currency area, the optimal monetary policy is compared to the one for a homogeneous area. In the model with heterogeneity, the relative competitiveness across regions influences the extent to which shocks are transmitted to the area-wide inflation and output gap. Under a plausible calibration for the EMU, the optimal policy plan exhibits a stronger tendency towards currency area exchange rate stabilization than the one in the homogeneity case. Moreover, it is welfare-improving to forgo some area-wide inflation stabilization to dampen inflation differentials.

Suggested Citation

  • Martina Cecioni, 2010. "External trade and monetary policy in a currency area," Temi di discussione (Economic working papers) 738, Bank of Italy, Economic Research and International Relations Area.
  • Handle: RePEc:bdi:wptemi:td_738_10
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    References listed on IDEAS

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    Cited by:

    1. Jochen Michaelis, 2012. "Optimal Monetary Policy in a Currency Union: The Role of the Cost Channel," MAGKS Papers on Economics 201203, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).

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    More about this item

    Keywords

    Monetary union; optimal monetary policy; loss function;
    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

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