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Participation in a Currency Union

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  • Casella, Alessandra

Abstract

When countries of different sizes participate in a cooperative agreement, the potential gain from deviation determines the minimum power that each country requires in the common decision-making. This paper studies the problem in the context of a common currency, which requires coordination of monetary policies. In the presence of externalities in the decentralized equilibrium with national currencies, it is shown that a small economy will in general require, and obtain, more than proportional power in the agreement. With a common currency, this is equivalent to a transfer of seigniorage revenues in its favour. With national currencies such transfer would not occur, and without additional unconstrained fiscal instruments it would be impossible to sustain coordination with fixed exchange rates. When the number of potential countries in the union is large, it is not generally possible to prevent deviations from individual countries or from coalitions. The probability of deviation rises sharply with the number of countries and of possible coalitions.

Suggested Citation

  • Casella, Alessandra, 1990. "Participation in a Currency Union," CEPR Discussion Papers 395, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:395
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    References listed on IDEAS

    as
    1. Alessandra Casella and Jonathan Feinstein., 1988. "Management of a Common Currency," Economics Working Papers 8891, University of California at Berkeley.
    2. Aizenman, Joshua, 1992. "Competitive Externalities and the Optimal Seigniorage," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 24(1), pages 61-71, February.
    3. John Kareken & Neil Wallace, 1981. "On the Indeterminacy of Equilibrium Exchange Rates," The Quarterly Journal of Economics, Oxford University Press, vol. 96(2), pages 207-222.
    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 865-890, October.
    5. Willem H. Buiter & Jonathan Eaton, 1983. "International Balance of Payments Financing and Adjustment," NBER Working Papers 1120, National Bureau of Economic Research, Inc.
    6. Bernheim, B. Douglas & Whinston, Michael D., 1987. "Coalition-Proof Nash Equilibria II. Applications," Journal of Economic Theory, Elsevier, vol. 42(1), pages 13-29, June.
    7. Cohen, Daniel & Wyplosz, Charles, 1989. "The European Monetary Union: An Agnostic Evaluation," CEPR Discussion Papers 306, C.E.P.R. Discussion Papers.
    8. Bernheim, B. Douglas & Peleg, Bezalel & Whinston, Michael D., 1987. "Coalition-Proof Nash Equilibria I. Concepts," Journal of Economic Theory, Elsevier, vol. 42(1), pages 1-12, June.
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    Keywords

    Cooperation; Currency Union; Seigniorage;

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