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Currency Areas and Monetary Coordination

Author

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  • Qing Liu
  • Shouyong Shi

Abstract

In this paper we integrate the recent development in monetary theory with international finance, in order to examine the coordination between two currency areas in setting long-run inflation. The model determines the value of each currency and the size of each currency area without requiring buyers to use a particular currency to buy a country's goods. We show that the two countries inflate above the Friedman rule in a non-cooperative game. Coordination between the two areas reduces inflation to the Friedman rule, increases consumption, and improves welfare of both countries. This gain from coordination increases as the two areas become more integrated in trade. These results arise from the new features of the model, such as the deviations from the law of one price and the extensive margin of trade. To illustrate these new features, we show that introducing a direct tax on foreign holdings of a currency does not eliminate a country's incentive to inflate, while it does in traditional models.

Suggested Citation

  • Qing Liu & Shouyong Shi, 2006. "Currency Areas and Monetary Coordination," Working Papers tecipa-226, University of Toronto, Department of Economics.
  • Handle: RePEc:tor:tecipa:tecipa-226
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    References listed on IDEAS

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    Cited by:

    1. Régis Breton & Mariana Rojas Breu & Vincent Bignon, 2013. "Monetary Union, Banks and Financial Integration," Post-Print hal-01685888, HAL.
    2. Vincent Bignon & Régis Breton & Mariana Rojas Breu, 2019. "Currency Union With Or Without Banking Union," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 60(2), pages 965-1003, May.
    3. Ding, Shuze & Puzzello, Daniela, 2020. "Legal restrictions and international currencies: An experimental approach," Journal of International Economics, Elsevier, vol. 126(C).
    4. Bignon, V. & Breton, R. & Rojas Breu, M., 2013. "Currency Union with and without Banking Union," Working papers 450, Banque de France.
    5. Shouyong Shi, 2006. "Viewpoint: A microfoundation of monetary economics," Canadian Journal of Economics, Canadian Economics Association, vol. 39(3), pages 643-688, August.
    6. Benjamin Eden, 2006. "International Seigniorage Payments," Vanderbilt University Department of Economics Working Papers 0622, Vanderbilt University Department of Economics.
    7. Yilmazkuday, Hakan, 2023. "Drivers of inflation convergence across countries: the role of standard gravity variables," Macroeconomic Dynamics, Cambridge University Press, vol. 27(6), pages 1664-1686, September.
    8. Li, Yiting & Matsui, Akihiko, 2009. "A theory of international currency: Competition and discipline," Journal of the Japanese and International Economies, Elsevier, vol. 23(4), pages 407-426, December.
    9. Liu, Tao & Lu, Dong & Woo, Wing Thye, 2019. "Trade, finance and international currency," Journal of Economic Behavior & Organization, Elsevier, vol. 164(C), pages 374-413.
    10. Ayman Mnasri & Beverly Lapham, 2023. "A competitive search approach to exchange rate pass-through," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 76(1), pages 153-201, July.
    11. Tao Liu & Dong Lu & Liang Wang, 2023. "Hegemony or Harmony? A Unified Framework for the International Monetary System," Working Papers 202305, University of Hawaii at Manoa, Department of Economics.
    12. Wang, Chenxi, 2023. "A model of international currency with private information," Journal of International Money and Finance, Elsevier, vol. 131(C).
    13. Zhang, Cathy, 2014. "An information-based theory of international currency," Journal of International Economics, Elsevier, vol. 93(2), pages 286-301.
    14. Shouyong Shi, 2006. "A Microfoundation of Monetary Economics," Working Papers tecipa-211, University of Toronto, Department of Economics.
    15. repec:dau:papers:123456789/12105 is not listed on IDEAS

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    More about this item

    Keywords

    Exchange rates; Currency areas; Coordination;
    All these keywords.

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General

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