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Fragmented Monetary Unions

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  • Luca Fornaro
  • Christoph Grosse Steffen

Abstract

We provide a theory of financial fragmentation in monetary unions. Our key insight is that currency unions may experience endogenous breakings of symmetry: that is episodes in which identical countries react differently when exposed to the same shock. During these events, part of the union suffers a capital flight, while the rest acts as a safe haven and receives capital inflows. The central bank then faces a difficult trade-off between containing unemployment in capital-flight countries and inflationary pressures in safe-haven ones. By counteracting private capital flows with public ones, anti-fragmentation monetary programs mitigate the impact of financial fragmentation on employment and inflation, thus helping the central bank to fulfil its price stability mandate.

Suggested Citation

  • Luca Fornaro & Christoph Grosse Steffen, 2024. "Fragmented Monetary Unions," Working papers 978, Banque de France.
    • Handle: RePEc:bfr:banfra:978
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    References listed on IDEAS

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    More about this item

    Keywords

    Monetary Unions; Euro Area; Fragmentation; Optimal Monetary Policy in Open Economies; Capital Flows; Fiscal Crises; Anti-Fragmentation Policies; Inflation; Endogenous Breaking of Symmetry; Optimal Currency Areas;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • 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
    • F45 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Macroeconomic Issues of Monetary Unions

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