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Management of a Common Currency

  • Casella, Alessandra
  • Feinstein, Jonathan

This paper presents a simple general equilibrium model of two countries using a common currency. The goal is to study how the monetary arrangement influences the optimum financing of a public good. If the two countries are allowed to print the common currency autonomously, they will finance their fiscal spending with money, oversupplying the public good and crowding out the private sector. The possibility to export part of the inflation creates a distortion in incentives such the resulting equilibrium is strictly welfare inferior to the one prevailing under flexible exchange rates. If the management of the common currency is deferred to an international central bank, each country will try to use domestic policy variables (taxes) to manipulate in its favor the actions of the bank. With no independent domestic taxes, the bank can improve welfare. However, its policies naturally support the larger country, and to induce the smaller one to participate requires giving it a disproportionately large, politically unrealistic, representation in the bank's objective function.

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Paper provided by Department of Economics, Institute for Business and Economic Research, UC Berkeley in its series Department of Economics, Working Paper Series with number qt5jv1h7nt.

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Date of creation: 22 Sep 1988
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Handle: RePEc:cdl:econwp:qt5jv1h7nt
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  1. Wood, Geoffrey E., 1986. "European monetary integration? A review essay," Journal of Monetary Economics, Elsevier, vol. 18(3), pages 329-336, November.
  2. Kehoe, Patrick J., 1987. "Coordination of fiscal policies in a world economy," Journal of Monetary Economics, Elsevier, vol. 19(3), pages 349-376, May.
  3. Kareken, John & Wallace, Neil, 1981. "On the Indeterminacy of Equilibrium Exchange Rates," The Quarterly Journal of Economics, MIT Press, vol. 96(2), pages 207-22, May.
  4. Helpman, Elhanan, 1981. "An Exploration in the Theory of Exchange-Rate Regimes," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 865-90, October.
  5. Helpman, Elhanan & Razin, Assaf, 1982. "Dynamics of a Floating Exchange Rate Regime," Scholarly Articles 3445095, Harvard University Department of Economics.
  6. Alberto Alesina, 1987. "A Positive Theory of Fiscal Deficits and Government Debt in a Democracy," UCLA Economics Working Papers 435, UCLA Department of Economics.
  7. Hamada, Koichi, 1976. "A Strategic Analysis of Monetary Interdependence," Journal of Political Economy, University of Chicago Press, vol. 84(4), pages 677-700, August.
  8. Bernheim, B Douglas & Whinston, Michael D, 1986. "Common Agency," Econometrica, Econometric Society, vol. 54(4), pages 923-42, July.
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