Welfare Implications of the Design of a Currency Union in Case of Member Countries of Different Sizes and Output Persistence

In the study, the relevance of several optimum-currency-area (OCA) criteria is formally worked out in a welfare approach. The optimum monetary-policy rules of the supranational central bank are derived within the Barro-Gordon framework, and consideration is given to how the welfare of the member countries of a currency union is affected by symmetric and asymmetric national output shocks. The welfare implications are deduced both analytically and with the use of simulations. In a twocountry framework, the countries are allowed to differ in size, and different degrees of labour mobility are addressed. Also the issue of output persistence is taken up. The central-bank council may consist of a central-bank board and of a group of national central-bank presidents, where the national presidents are assumed to focus on their home economies. It is shown that relatively small member countries favour a situation where the group of national central bank presidents is in a strong position while large countries prefer decisions to be taken by the central-bank board. The preferences are the less strong the higher the degree of labour mobility. With output persistence, labour migration also moderates the disadvantages of the decisions taken by a central-bank board for a relatively small country. Furthermore, for output persistence in conjuncture with labour migration, monetary policy by a small country within the group of national presidents may negatively affect its future welfare. Besides, differences in the national monetary transmission processes as well as divergent national inflation and output preferences affect welfare.