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Monetary Policy in a Currency Union with National Price Asymmetries

  • Sandra Gomes

We investigate the importance of the behaviour of the monetary authority for the dynamics of a currency union where cross-country asymmetries are not necessarily reflected in differences in economic size. We construct a stylised two-country general equilibrium model with sticky-prices to serve as laboratory for studying the operating characteristics of Taylor-type interest rate rules. We consider that the two countries in the union are different in terms of the price-setting practices of firms, and inspect the implications of alternative policy rules for the dynamics of the economy. The experiments carried out show, in general, that the way shocks propagate in the monetary union is linked to the systematic behaviour of the monetary authority. The reaction of the central bank to economic developments is important both at the union level and at the country level, namely to explain cross-country differences in economic behaviour. On the other hand, in our model the policy that stabilizes inflation is not necessarily the same that makes the output in the union less volatile. Also, the policy that reduces aggregate volatility does not necessarily imply the same for each country individually.

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Paper provided by Banco de Portugal, Economics and Research Department in its series Working Papers with number w200416.

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Date of creation: 2004
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Handle: RePEc:ptu:wpaper:w200416
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  1. Andrew T. Levin & John C. Williams, 2003. "Robust monetary policy with competing reference models," Working Paper Series 2003-10, Federal Reserve Bank of San Francisco.
  2. Baudry, L. & Le Bihan, H. & Sevestre, P. & Tarrieu, S., 2004. "Price Rigidity. Evidence from the French CPI Macro-Data," Working papers 113, Banque de France.
  3. Margarida Duarte & Alexander L. Wolman, 2003. "Fiscal policy and regional inflation in a currency union," Working Paper 03-11, Federal Reserve Bank of Richmond.
  4. Rochelle M. Edge, 2001. "Online Appendix to "The Equivalence of Wage and Price Staggering in Monetary Business Cycle Models"," Technical Appendices edge01, Review of Economic Dynamics.
  5. Dias, Mónica & Dias, Daniel & Neves, Pedro D., 2004. "Stylised features of price setting behaviour in Portugal: 1992-2001," Working Paper Series 0332, European Central Bank.
  6. Niki X. Papadopoulou, 2008. "Sticky Prices, Limited Participation, or Both?," Working Papers 2008-4, Central Bank of Cyprus.
  7. William T. Gavin & Finn E. Kydland, 1996. "Endogenous money supply and the business cycle," Working Paper 9605, Federal Reserve Bank of Cleveland.
  8. Mikhail Golosov & Robert E. Lucas, 2003. "Menu Costs and Phillips Curves," NBER Working Papers 10187, National Bureau of Economic Research, Inc.
  9. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
  10. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999 1151, Society for Computational Economics.
  11. Miguel Casares, 2001. "Business Cycle and Monetary Policy Analysis in a Structural Sticky- Price Model of The Euro Area," Documentos de Trabajo - Lan Gaiak Departamento de Economía - Universidad Pública de Navarra 0109, Departamento de Economía - Universidad Pública de Navarra.
  12. Rochelle M. Edge, 2000. "The equivalence of wage and price staggering in monetary business cycle models," International Finance Discussion Papers 672, Board of Governors of the Federal Reserve System (U.S.).
  13. Andrew Levin & Volker Wieland & John C. Williams, 2001. "The performance of forecast-based monetary policy rules under model uncertainty," Finance and Economics Discussion Series 2001-39, Board of Governors of the Federal Reserve System (U.S.).
  14. Mark J. Zbaracki & Mark Ritson & Daniel Levy & Shantanu Dutta & Mark Bergen, 2004. "Managerial and Customer Costs of Price Adjustment: Direct Evidence from Industrial Markets," The Review of Economics and Statistics, MIT Press, vol. 86(2), pages 514-533, May.
  15. Nicoletta Batini & Andrew Haldane, 1999. "Forward-Looking Rules for Monetary Policy," NBER Chapters, in: Monetary Policy Rules, pages 157-202 National Bureau of Economic Research, Inc.
  16. Benigno, Pierpaolo, 2001. "Optimal Monetary Policy in a Currency Area," CEPR Discussion Papers 2755, C.E.P.R. Discussion Papers.
  17. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
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