Fragmented Monetary Unions

Luca Fornaro and Christoph Grosse Steffen

Working papers from Banque de France

Abstract: We provide a theory of financial fragmentation in monetary unions. Our key insight is that currency unions may experience endogenous breakings of symmetry: that is episodes in which identical countries react differently when exposed to the same shock. During these events, part of the union suffers a capital flight, while the rest acts as a safe haven and receives capital inflows. The central bank then faces a difficult trade-off between containing unemployment in capital-flight countries and inflationary pressures in safe-haven ones. By counteracting private capital flows with public ones, anti-fragmentation monetary programs mitigate the impact of financial fragmentation on employment and inflation, thus helping the central bank to fulfil its price stability mandate.

Keywords: Monetary Unions; Euro Area; Fragmentation; Optimal Monetary Policy in Open Economies; Capital Flows; Fiscal Crises; Anti-Fragmentation Policies; Inflation; Endogenous Breaking of Symmetry; Optimal Currency Areas (search for similar items in EconPapers)
JEL-codes: E31 E52 F32 F41 F42 F45 (search for similar items in EconPapers)
Pages: 46 pages
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:bfr:banfra:978

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