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Central bank credibility, long-term yields and the effects of monetary integration

Author

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  • Marcin Kolasa
  • Dominik Supera

Abstract

Forming a monetary union implies equalization of short-term interest rates across the member states as monetary policy is delegated to a common central bank, but also leads to integration of risk-free bond markets. In this paper we develop a quantitative open economy model where long-term bond yields matter for real allocations. We next use the model to shed light on the macroeconomic effects of convergence in bond prices within a currency union. Our focus is on a small open economy, where the pre-accession level of interest rates is high due to floating exchange rate and relatively low central bank focus on stabilizing inflation. We find that, from the perspective of social welfare in the country adopting a common currency, the benefits associated with lower long-term yields can outweigh the costs related to a loss of monetary independence.

Suggested Citation

  • Marcin Kolasa & Dominik Supera, 2021. "Central bank credibility, long-term yields and the effects of monetary integration," KAE Working Papers 2021-061, Warsaw School of Economics, Collegium of Economic Analysis.
    • Handle: RePEc:sgh:kaewps:2021061
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    File URL: http://kolegia.sgh.waw.pl/pl/KAE/Documents/WorkingPapersKAE/WPKAE_2021_061.pdf
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    More about this item

    Keywords

    monetary integration; bond yields; central bank credibility;
    All these keywords.

    JEL classification:

    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F45 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Macroeconomic Issues of Monetary Unions

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