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Management of a Common Currency

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  • Alessandra Casella and Jonathan Feinstein.

Abstract

This paper presents a simple general equilibrium model of two countries using a common currency. The goal is to study how the monetary arrangement influences the optimum financing of a public good. If the two countries are allowed to print the common currency autonomously, they will finance their fiscal spending with money, oversupplying the public good and crowding out the private sector. The possibility to export part of the inflation creates a distortion in incentives such the resulting equilibrium is strictly welfare inferior to the one prevailing under flexible exchange rates. If the management of the common currency is deferred to an international central bank, each country will try to use domestic policy variables (taxes) to manipulate in its favor the actions of the bank. With no independent domestic taxes, the bank can improve welfare. However, its policies naturally support the larger country, and to induce the smaller one to participate requires giving it a disproportionately large, politically unrealistic, representation in the bank's objective function.
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Suggested Citation

  • Alessandra Casella and Jonathan Feinstein., 1988. "Management of a Common Currency," Economics Working Papers 8891, University of California at Berkeley.
  • Handle: RePEc:ucb:calbwp:8891
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    References listed on IDEAS

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    1. Kehoe, Patrick J., 1987. "Coordination of fiscal policies in a world economy," Journal of Monetary Economics, Elsevier, vol. 19(3), pages 349-376, May.
    2. Wood, Geoffrey E., 1986. "European monetary integration? A review essay," Journal of Monetary Economics, Elsevier, vol. 18(3), pages 329-336, November.
    3. Alberto Alesina, 1987. "A Positive Theory of Fiscal Deficits and Government Debt in a Democracy," UCLA Economics Working Papers 435, UCLA Department of Economics.
    4. Helpman, Elhanan & Razin, Assaf, 1982. "Dynamics of a Floating Exchange Rate Regime," Journal of Political Economy, University of Chicago Press, vol. 90(4), pages 728-754, August.
    5. John Kareken & Neil Wallace, 1981. "On the Indeterminacy of Equilibrium Exchange Rates," The Quarterly Journal of Economics, Oxford University Press, vol. 96(2), pages 207-222.
    6. Bernheim, B Douglas & Whinston, Michael D, 1986. "Common Agency," Econometrica, Econometric Society, vol. 54(4), pages 923-942, July.
    7. Helpman, Elhanan, 1981. "An Exploration in the Theory of Exchange-Rate Regimes," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 865-890, October.
    8. Hamada, Koichi, 1976. "A Strategic Analysis of Monetary Interdependence," Journal of Political Economy, University of Chicago Press, vol. 84(4), pages 677-700, August.
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    Cited by:

    1. Guillaume Cheikbossian, 2001. "When a Monetary Union Fails: A Parable," Open Economies Review, Springer, vol. 12(2), pages 181-195, April.
    2. Barry Eichengreen, 1991. "Designing a Central Bank for Europe: A Cautionary Tale From the Early Years of the Federal Reserve System," NBER Working Papers 3840, National Bureau of Economic Research, Inc.
    3. Casella, Alessandra, 1992. "Participation in a Currency Union," American Economic Review, American Economic Association, vol. 82(4), pages 847-863, September.
    4. Dominique Hachette & Fernando Ossa & Francisco Rosende, 1996. "Aspectos Monetarios y Macroeconómicos de la Integración," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 33(98), pages 153-183.
    5. Patrick Artus, 1992. "Passage à l'union économique et monétaire en Europe : effets sur la croissance et les politiques budgétaires," Économie et Prévision, Programme National Persée, vol. 106(5), pages 123-137.
    6. Russell Cooper & Hubert Kempf, 1998. "Establishing a Monetary Union," Boston University - Institute for Economic Development 88, Boston University, Institute for Economic Development.
    7. Richard Pomfret, 2003. "Formation and Dissolution of Monetary Unions: Evidence from Europe, and Lessons for Elsewhere," School of Economics Working Papers 2003-03, University of Adelaide, School of Economics.
    8. Joshua Aizenman, 1989. "The Competitive Externalities and the Optimal Seignorage," NBER Working Papers 2937, National Bureau of Economic Research, Inc.
    9. Joshua Aizenman & Peter Isard, 1990. "Externalities, Incentives, and Economic Reforms," NBER Working Papers 3395, National Bureau of Economic Research, Inc.

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