Currency areas and voluntary transfers

Pierre Picard and Timothy Worrall

Journal of International Economics, 2020, vol. 127, issue C

Abstract: Fiscal integration is recognized as an important issue in determining whether countries establish a common currency area. Fiscal integration between sovereign states is, however, limited by the ability of countries to commit to fiscal transfers. This paper supposes that fiscal transfers between countries must be voluntary and asks how this influences the choice between a currency area and a flexible exchange rate regime. It presents a model with wage rigidity in which, absent transfers, the flexible exchange rate regime is preferred. If there are transfers that equalize consumption, then the choice of exchange rate regime is irrelevant. Nevertheless, the currency area may be preferable if transfers are made voluntarily, because the currency area can sustain greater risk sharing. It is shown that the currency area can be optimal for a plausible set of parameter values. We consider the robustness of the conclusions to some modifications of the model.

Keywords: Optimal currency area; Fiscal union; Limited commitment; Mutual insurance (search for similar items in EconPapers)
JEL-codes: F12 F15 F31 F33 F45 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Working Paper: Currency Areas and Voluntary Transfers (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:inecon:v:127:y:2020:i:c:s0022199620301057

DOI: 10.1016/j.jinteco.2020.103390

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