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Monetary Policy in a Currency Union with Heterogeneous Limited Asset Markets Participation

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  • Fabian Eser

    () (Nuffield College, Oxford University, Oxford.)

Abstract

This paper examines monetary policy in a currency union whose member countries exhibit heterogeneous rates of limited asset markets participation (LAMP). As a result risk sharing among member countries is imperfect and the monetary transmission mechanism can differ across countries. In the limit the elasticity of output to the union-wide nominal interest rate can be of opposite sign in different countries. I develop a tractable model in which the dispersion of asset markets participation (AMP) becomes a key parameter. While monetary policy can guarantee determinacy by following an active or passive rule depending on the sign of the interest-elasticity of output, ignoring dispersion can lead to incorrect computation of the sign and the size of the latter. Taking the heterogeneity into account is thus central for sound policy Furthermore, due to the failure of risk sharing, determinacy for union-aggregates does not guarantee determinacy in every member country. However, the more open a country is in trade terms, the greater the rate of LAMP for which the country still displays equilibrium determinacy. For complete openness, determinacy is guaranteed. This underlines the importance of risk sharing and trade integration for the functioning of a currency union. Considering the optimal union-wide targeting rule, a higher mean and dispersion of LAMP increase the desired inflation volatility and decrease the desired output volatility. The implied optimal Taylor rule shows that subject to the Taylor principle, the higher are mean and dispersion of LAMP, the softer should be the response of the nominal interest rate to expected inflation.

Suggested Citation

  • Fabian Eser, 2009. "Monetary Policy in a Currency Union with Heterogeneous Limited Asset Markets Participation," Economics Papers 2009-W16, Economics Group, Nuffield College, University of Oxford.
  • Handle: RePEc:nuf:econwp:0916
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    References listed on IDEAS

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    Cited by:

    1. Job Boerma, 2014. "Openness and the (inverted) aggregate demand logic," DNB Working Papers 436, Netherlands Central Bank, Research Department.
    2. Iyer, Tara, 2016. "Optimal Monetary Policy in an Open Emerging Market Economy," Working Paper Series WP-2016-6, Federal Reserve Bank of Chicago.

    More about this item

    Keywords

    Monetary Union; Limited Asset Markets Participation; Heterogeneity; (Optimal) Monetary Policy; Real (In)determinacy; Sticky Prices;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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