Central bank credibility, long-term yields and the effects of monetary integration

Marcin Kolasa and Dominik Supera

No 2021-061, KAE Working Papers from Warsaw School of Economics, Collegium of Economic Analysis

Abstract: Forming a monetary union implies equalization of short-term interest rates across the member states as monetary policy is delegated to a common central bank, but also leads to integration of risk-free bond markets. In this paper we develop a quantitative open economy model where long-term bond yields matter for real allocations. We next use the model to shed light on the macroeconomic effects of convergence in bond prices within a currency union. Our focus is on a small open economy, where the pre-accession level of interest rates is high due to floating exchange rate and relatively low central bank focus on stabilizing inflation. We find that, from the perspective of social welfare in the country adopting a common currency, the benefits associated with lower long-term yields can outweigh the costs related to a loss of monetary independence.

Keywords: monetary integration; bond yields; central bank credibility (search for similar items in EconPapers)
JEL-codes: E30 E43 E44 E52 F45 (search for similar items in EconPapers)
Pages: 27 pages
Date: 2021-01
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:sgh:kaewps:2021061

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