Stability and Eurozone membership: Should a small transition country join?

Timo Baas

No 6916, EcoMod2014 from EcoMod

Abstract: In the last years, Baltic countries joined or prepare to join the European Monetary Union. Accession comes in a time, were trading share between these countries and the Eurozone are declining. From a theoretical point of view, the optimality of currency unions depends on bilateral trade between it's members. In this paper it is shown that countries might benefit from a currency union as an alternative to fixed exchange rates. Using a DSGE model of a small country and a currency union, it is shown that membership in the union is beneficial to a fixed exchange rate system without a common monetary policy in terms of output and price stability. This result is robust even if trading shares decline significantly.In this paper we compare different monetary policy rules in a two-country open-economy DSGE model with Calvo price setting. Membership in the currency union is always beneficial in terms of macroeconomic stability. The benefits of joining a monetary union, however, are increasing with a declining share of foreign goods in the consumption basket of domestic households. The decision of Baltic countries to join the monetary union, therefore, is a second best solution in an environment were there is a fear of floating.

Keywords: Baltic countries; General equilibrium modeling (CGE); EU enlargement (search for similar items in EconPapers)
Date: 2014-07-03
New Economics Papers: this item is included in nep-dge, nep-eec, nep-mac, nep-mon and nep-opm
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Persistent link: https://EconPapers.repec.org/RePEc:ekd:006356:6916

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