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Home biased expectations and macroeconomic imbalances in a monetary union

Dennis Bonam () and Gavin Goy

DNB Working Papers from Netherlands Central Bank, Research Department

Abstract: Under monetary union, economic dynamics may diverge across countries due to regional inflation differentials and a pro-cyclical real interest rate channel, yet stability is generally ensured through endogenous adjustment of the real exchange rate. The speed of adjustment depends, inter alia, on the way agents form expectations. We propose a model in which agents' expectations are largely based on domestic variables, and less so on foreign variables. We show that such home bias in expectations strengthens the real interest rate channel and causes country-specific shocks to generate larger and more prolonged macroeconomic imbalances.

Keywords: monetary union; macroeconomic imbalances; home biased expectations; E-stability (search for similar items in EconPapers)
JEL-codes: E03 F44 F45 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac, nep-mon and nep-opm
Date: 2017-05
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Persistent link: https://EconPapers.repec.org/RePEc:dnb:dnbwpp:556

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