Designing Stabilization Policy in a Monetary Union
The European Monetary Union (EMU) has become a reality, but economists nonetheless continue to debate the desirability and the optimal design of a monetary union. Since a union's essential element is delegation of monetary power to a single centralized entity, one of the key issues in this debate is whether a monetary union will limit the effectiveness of stabilization policy. If so, it will not necessarily be welfare-improving. Having studied a two-country world economy and considered various designs of monetary union, the authors argue that the success of monetary union depends on 1) the commitment ability of the single central bank; 2) the policy flexibility of national fiscal authorities and the central monetary authority; and 3) the cross-country correlation of shocks.
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