The political economy of currency unions

Kai Arvai

Journal of International Economics, 2024, vol. 152, issue C

Abstract: How can monetary and fiscal policy sustain a currency union when member states have an exit option? This paper derives an interest rate rule that features state-dependent country weights with which the central bank can prevent a break-up. A simulation reveals that this policy rule lacks firepower and can only extend the lifetime of the union for a while. While monetary policy is more potent in unions with more member states or setups with local currency pricing, it is still true that even a simple fiscal union with lump-sum transfers is better suited to prevent a break-up. Environments with lower risk sharing, the ZLB or wage rigidity make monetary policy even less effective.

Keywords: Currency union; Monetary policy; Lack of commitment; Exit option; Fiscal policy (search for similar items in EconPapers)
JEL-codes: E42 E52 E61 F33 F45 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:inecon:v:152:y:2024:i:c:s0022199624001181

DOI: 10.1016/j.jinteco.2024.103991

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