Common Currencies vs. Monetary Independence

Thomas Cooley and Vincenzo Quadrini

The Review of Economic Studies, 2003, vol. 70, issue 4, 785-806

Abstract: We study the optimal monetary policy in a two-country open-economy model under two monetary arrangements: (a) multiple currencies controlled by independent policy makers; (b) common currencies with a centralized policy maker.Our findings suggest that: (i) monetary policy competition leads to higher long-term inflation and interest rates with large welfare losses; (ii) the inflation bias and the consequent losses are larger when countries are unable to commit to future policies; (iii) the welfare losses from higher long-term inflation dominates the welfare costs of losing the ability to react optimally to shocks. Copyright 2003, Wiley-Blackwell.

Date: 2003
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