The Political Economy of Currency Unions

Kai Arvai ()

Working papers from Banque de France

Abstract: How can a currency union be sustained when member states have an exit option? This paper derives how fiscal and monetary policies can ensure the survival of a common currency, i countries want to leave the union. A union-wide central bank can prevent a break-up by setting interest rates in favor of the country that wants to exit. I show how a central bank does this by following a monetary rule with state-dependent country weights. The paper then demonstrates in a simulation that a central bank can only sustain the union for a while with this rule, but not permanently and that the best way to sustain the union is through fiscal transfers.

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)
Pages: 78 pages
Date: 2021
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge, nep-mac, nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:bfr:banfra:850

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