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Do the ECB and the Fed really need to cooperate? Optimal monetary policy in a two-country world

A two-country model with monopolistic competition and price stickiness is employed to investigate the implications for macroeconomic stability and the welfare properties of three international policy arrangements: (a) cooperative, (b) non-cooperative and (c) monetary union. I characterize the conditions under which there is scope for policy cooperation and quantify the costs of non cooperation and monetary union. The non-cooperative equilibrium may be suboptimal because of beggar-thy-neighbor and beggar-thyself effects, while monetary union may be suboptimal because of the sluggishness of relative prices. Both the costs of policy competition and of a monetary union are sensitive to the values assumed for the intertemporal and international demand elasticity and the degree of openness of the economy. Independently of the calibration scenario adopted, the ECB has little to gain by coordinating with the Fed.

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File URL: http://eprints.lse.ac.uk/512/
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Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 512.

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Date of creation: May 2004
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Publication status: Published in Journal of Monetary Economics, May, 2004, 51(4), pp. 753-779. ISSN: 0304-3932
Handle: RePEc:ehl:lserod:512
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