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Asymmetric Information and Monetary Policy in Common Currency Areas

Laura Bottazzi () and Paolo Manasse ()

Journal of Money, Credit and Banking, 2005, vol. 37, issue 4, 603-21

Abstract: In a common currency area, the common central bank sets a uniform rate of inflation across countries, taking into account the area's economic conditions. Suppose countries in recession favor a more expansionary policy than countries in expansion: when national business cycles are not fully synchronized, a conflict of interest between members arises. If member governments have an informational advantage over the state of their domestic economy, such conflict may create an adverse selection problem: national authorities overemphasize their shocks in order to shape the common policy towards their needs. This creates an inefficiency over and above the one-policy-fits-all cost discussed in the optimal currency area literature. In order to minimize this extra-burden of asymmetric information, monetary policy must over-react to large symmetric shocks and under-react to asymmetric shocks of different sizes.

Date: 2005
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Working Paper: Asymmetric Information and Monetary Policy in Common Currency Areas (2002) Downloads
Working Paper: Asymmetric Information and Monetary Policy in Common Currency Areas (2002) Downloads
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