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The Inherent Benefit of Monetary Unions

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  • Groll, Dominik
  • Monacelli, Tommaso

Abstract

The desirability of flexible exchange rates is a central tenet in international macroeconomics. We show that, with forward-looking staggered pricing, this result crucially depends on the monetary authority's ability to commit. Under full commitment, flexible exchange rates generally dominate a monetary union (or fixed exchange rate) regime. Under discretion, this result is overturned: a monetary union dominates flexible exchange rates. By fixing the nominal exchange rate, a benevolent monetary authority finds it welfare improving to tradeoff flexibility in the adjustment of the terms of trade in order to improve on its ability to manage the private sector's expectations. Thus, inertia in the terms of trade (induced by a fixed exchange rate) is a cost under commitment, whereas it is a benefit under discretion, for it acts like a commitment device.

Suggested Citation

  • Groll, Dominik & Monacelli, Tommaso, 2016. "The Inherent Benefit of Monetary Unions," CEPR Discussion Papers 11416, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:11416
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    References listed on IDEAS

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    1. repec:eee:inecon:v:115:y:2018:i:c:p:80-98 is not listed on IDEAS
    2. Hettig, Thomas & Müller, Gernot J., 2018. "Fiscal policy coordination in currency unions at the effective lower bound," Journal of International Economics, Elsevier, vol. 115(C), pages 80-98.

    More about this item

    Keywords

    commitment; discretion; flexible exchange rates; monetary union; nominal rigidities.; welfare losses;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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