When to Leave a Monetary Union: Now or Later?

Frank Strobel

No 961, Econometric Society World Congress 2000 Contributed Papers from Econometric Society

Abstract: Using a two-country model of monetary union where policymakers minimize the continuous-time equivalent of a Barro-Gordon-type loss function, we examine the value of the option of monetary break-up when the national preference parameters associated with an inflationary surprise follow correlated geometric Brownian motions. We derive the critical level of the ratio of these parameters that triggers a move to monetary disintegration and find that a country will be willing to return to monetary independence only if the other country's relative inflation preferences are strictly, and potentially substantially, greater than a benchmark value depending on the cost of monetary break-up alone.

Date: 2000-08-01
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