The Inherent Benefit of Monetary Unions

Tommaso Monacelli and Dominik Groll

No 11416, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: The desirability of flexible exchange rates is a central tenet in international macroeconomics. We show that, with forward-looking staggered pricing, this result crucially depends on the monetary authority's ability to commit. Under full commitment, flexible exchange rates generally dominate a monetary union (or fixed exchange rate) regime. Under discretion, this result is overturned: a monetary union dominates flexible exchange rates. By fixing the nominal exchange rate, a benevolent monetary authority finds it welfare improving to tradeoff flexibility in the adjustment of the terms of trade in order to improve on its ability to manage the private sector's expectations. Thus, inertia in the terms of trade (induced by a fixed exchange rate) is a cost under commitment, whereas it is a benefit under discretion, for it acts like a commitment device.

Keywords: Monetary union; Flexible exchange rates; Commitment; Discretion; Welfare losses; Nominal rigidities (search for similar items in EconPapers)
JEL-codes: E52 F33 F41 (search for similar items in EconPapers)
Date: 2016-07
New Economics Papers: this item is included in nep-cse, nep-mac, nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Journal Article: The inherent benefit of monetary unions (2020)
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