The Political Economy of a Diverse Monetary Union

Enrico Perotti and Oscar Soons
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Oscar Soons: University of Amsterdam

No 20-045/IV, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: We analyze the political economy of monetary unification among countries with different quality of institutions. Countries with stronger institutions have lower public spending and better productive incentives, even under a stronger currency. Governments under weaker institutions spend more and must occasionally devalue. In a diverse monetary union prices and flows adjust quickly while institutional differences persist, so the common exchange rate has large redistributive effects. Public spending in the weaker country is less constrained and may rise, so productive incentives are reduced by both a fiscal and common exchange rate effect. A weak country government may agree to a common currency that reduces productive capacity as it enables more public spending. Strong country production benefits from a weaker currency, but in a crisis the survival of the monetary union may require fiscal transfers, justified by the implicit gains. Even when a diverse monetary union is on aggregate beneficial to all countries, firms in weaker countries and savers in stronger countries lose.

Keywords: Monetary unions; institutional quality; political economy; fiscal union; fiscal transfers (search for similar items in EconPapers)
JEL-codes: D72 F33 F45 O47 (search for similar items in EconPapers)
Date: 2020-07-27, Revised 2020-09-08
New Economics Papers: this item is included in nep-opm
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Citations: View citations in EconPapers (1)

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Related works:
Working Paper: The Political Economy of a Diverse Monetary Union (2020)
Working Paper: The Political Economy of a Diverse Monetary Union (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:tin:wpaper:20200045

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