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Monetary policy and welfare in a currency union

Published online by Cambridge University Press:  11 April 2022

Lucio D’Aguanno
Lucio D’Aguanno*
Affiliation:
Bank of England, Threadneedle Street, London, EC2R 8AH, UK
*
Email: [email protected]
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Abstract

I explore the welfare implications of currency union (CU) membership in a model that generates a trade-off between alternative monetary arrangements. While national currencies support country-specific monetary policies, a CU eliminates some barriers to trade and transitory cross-border price misalignments caused by nominal rigidities. I quantify the welfare gap between these two arrangements and show that it depends crucially on the correlation of shocks across the countries involved. I estimate the model with data from 11 Eurozone members and I seek the minimum trade gains needed to make a single currency worthwhile for them. I find that modest trade gains are likely to be sufficient, given the good business-cycle affiliation of these economies.

Keywords

Currency unionincomplete marketsnominal rigiditieslocal currency pricingtrade frictions
Type
Articles
Information
Macroeconomic Dynamics , Volume 27 , Issue 4 , June 2023 , pp. 1089 - 1114
Copyright
© The Author(s), 2022. Published by Cambridge University Press

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Footnotes

This paper is a revised version of the second chapter of my doctoral dissertation written at the University of Warwick. The views expressed are solely those of the author and so cannot be taken to represent those of the Bank of England or to state Bank of England policy. This paper should therefore not be reported as representing the views of the Bank of England or members of the Monetary Policy Committee, Financial Policy Committee, or Prudential Regulation Committee. I am grateful to Roberto Pancrazi and Marcus Miller for their guidance. I thank Thijs van Rens, Marija Vukotić, Michael McMahon, Juan Carlos Gozzi, Federico Di Pace and seminar participants at the Warwick Macro and International Economics Workshop, the 41st Simposio of the Spanish Economic Association, the Federal Reserve Bank of Boston, the Bank of Spain, the Bank of England and Birkbeck, and University of London for insightful comments on an earlier version of this work. My gratitude extends to Herakles Polemarchakis and Giovanni Ricco for valuable suggestions. This research did not receive any specific grant from funding agencies in the public, commercial, or non-for-profit sectors.

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