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Common Currencies versus Monetary Independence

  • Cooley, Thomas F
  • Quadrini, Vincenzo

We study the optimal monetary policy in a two-country open-economy model under two monetary arrangements: (a) multiple currencies controlled by independent policy-makers; (b) common currencies controlled by a centralized policy-maker. Our findings suggest that: (i) Monetary policy competition leads to higher long-term inflation and interest rates with large welfare losses; (ii) The inflation bias and the consequent losses are larger when countries are unable to commit to future policies; (iii) in both cases, the welfare losses from higher in ation dominates the welfare costs of losing the ability to react optimally to business cycle shocks. Therefore, the coordination of policies implicit in the adoption of a common currency or dollarization has positive welfare consequences.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3436.

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Date of creation: Jun 2002
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Handle: RePEc:cpr:ceprdp:3436
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  1. Obstfeld, Maurice & Rogoff, Kenneth S., 1995. "Exchange Rate Dynamics Redux," Scholarly Articles 12491026, Harvard University Department of Economics.
  2. Alberto Alesina & Robert J. Barro, 2000. "Currency Unions," NBER Working Papers 7927, National Bureau of Economic Research, Inc.
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  4. Reinert, Kenneth A. & Roland-Holst, David W., 1992. "Armington elasticities for United States manufacturing sectors," Journal of Policy Modeling, Elsevier, vol. 14(5), pages 631-639, October.
  5. Maurice Obstfeld & Kenneth Rogoff, 2000. "New Directions for Stochastic Open Economy Models," International Finance 0004002, EconWPA.
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  8. Alan C. Stockman & Linda L. Tesar, 1990. "Tastes and Technology in a Two-Country Model of the Business Cycle: Explaining International Comovements," NBER Working Papers 3566, National Bureau of Economic Research, Inc.
  9. Giancarlo Corsetti & Paolo Pesenti, 1997. "Welfare and Macroeconomic Interdependence," NBER Working Papers 6307, National Bureau of Economic Research, Inc.
  10. Patrick J. Kehoe & Andrew Atkeson, 1999. "Models of Energy Use: Putty-Putty versus Putty-Clay," American Economic Review, American Economic Association, vol. 89(4), pages 1028-1043, September.
  11. Matthew B. Canzoneri & Robert E. Cumby & Behzad T. Diba, 2002. "The Need for International Policy Coordination: What's Old, What's New, What's Yet to Come?," NBER Working Papers 8765, National Bureau of Economic Research, Inc.
  12. Backus, David K & Kehoe, Patrick J & Kydland, Finn E, 1994. "Dynamics of the Trade Balance and the Terms of Trade: The J-Curve?," American Economic Review, American Economic Association, vol. 84(1), pages 84-103, March.
  13. Evi Pappa, 2004. "Do the ECB and the Fed really need to cooperate? Optimal monetary policy in a two-country world," LSE Research Online Documents on Economics 512, London School of Economics and Political Science, LSE Library.
  14. Corsetti, Giancarlo & Pesenti, Paolo & Roubini, Nouriel & Tille, Cedric, 2000. "Competitive devaluations: toward a welfare-based approach," Journal of International Economics, Elsevier, vol. 51(1), pages 217-241, June.
  15. Corsetti, Giancarlo & Pesenti, Paolo, 2005. "International dimensions of optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 52(2), pages 281-305, March.
  16. Gianluca Benigno & Pierpaolo Benigno, 2003. "Price Stability in Open Economies," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 743-764, October.
  17. Maurice Obstfeld & Kenneth Rogoff, 2000. "Do We Really Need a New International Monetary Compact?," NBER Working Papers 7864, National Bureau of Economic Research, Inc.
  18. Persson, Torsten & Tabellini, Guido, 1995. "Double-edged incentives: Institutions and policy coordination," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 38, pages 1973-2030 Elsevier.
  19. Grilli, Vittorio & Roubini, Nouriel, 1992. "Liquidity and exchange rates," Journal of International Economics, Elsevier, vol. 32(3-4), pages 339-352, May.
  20. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
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