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Working Paper
A theory of the currency denomination of international trade
Nominal rigidities due to menu costs have become a standard element in closed economy macroeconomic modeling. The "New Open Economy Macroeconomics" literature has investigated the implications of nominal rigidities in an open economy context and found that the currency in which prices are set has significant macroeconomic and policy implications. In this paper we solve for the optimal invoicing choice by integrating this microeconomic decision at the firm level into a general equilibrium open economy model. Strategic interactions between firms play a critical role in the analysis. We find ...
Working Paper
On the need for fiscal constraints in a monetary union
Working Paper
Would the Euro Area Benefit from Greater Labor Mobility?
We assess how within euro area labor mobility impacts economic dynamics in response to shocks. In the analysis we use an estimated two-region monetary union dynamic stochastic general equilibrium model that allows for a varying degree of labor mobility across regions. We find that, in contrast with traditional optimal currency area predictions, enhanced labor mobility can either mitigate or exacerbate the extent to which the two regions respond differently to shocks. The effects depend crucially on the nature of shocks and variable of interest. In some circumstances, even when it contributes ...
Working Paper
Monetary policy and the financial accelerator in a monetary union
In this paper, we consider the effect of a monetary union in a model with a significant role for financial market imperfections. We do so by introducing a financial accelerator into a stochastic general equilibrium macro model of a two country economy. We show that financial market imperfections introduce important cross-country transmission mechanisms to asymmetric shocks to supply and demand. Within this framework, we study the likely costs and benefits of monetary union. We also consider the effects of cross-country heterogeneity in financial markets. Both the presence of financial ...
Report
On the desirability of fiscal constraints in a monetary union
The desirability of fiscal constraints in monetary unions depends critically on whether the monetary authority can commit to follow its policies. If it can commit, then debt constraints can only impose costs. If it cannot commit, then fiscal policy has a free-rider problem, and debt constraints may be desirable. This type of free-rider problem is new and arises only because of a time inconsistency problem.
Working Paper
Asymmetric shocks in a currency union with monetary and fiscal handcuffs?
This paper investigates the impact of the asymmetric shocks within a currency union in a framework that takes account of the zero bound constraint on policy rates, and also allows for constraints on fiscal policy. In this environment, we document that the usual optimal currency argument showing that the effects of shocks are mitigated to the extent that they are common across member states can be reversed. Countries can be worse off when their neighbors experience similar shocks, including policy-driven reductions in government spending.
Journal Article
Does Europe's path to monetary union provide lessons for East Asia?
In 1999, eleven European countries adopted the euro as their common currency (Greece followed in 2001). This followed a long period of gradually tying their national currencies together more tightly by limiting exchange rate fluctuations among member countries, culminating in the European Monetary Union (EMU). The experience of Europe has raised the question as to whether countries in other regions of the world can and should follow a similar path towards adopting a common currency. ; East Asia, with some of the most dynamically growing economies in the world, has long been considered a ...
Report
Overturning Mundell: fiscal policy in a monetary union
Central to ongoing debates over the desirability of monetary unions is a supposed trade-off, outlined by Mundell [1961]: a monetary union reduces transactions costs but renders stabilization policy less effective. If shocks across countries are sufficiently correlated, then, according to this argument, delegating monetary policy to a single central bank is not very costly and a monetary union is desirable.> This paper explores this argument in a setting with both monetary and fiscal policies. In an economy with monetary policy alone, we confirm the presence of the trade-off and find that ...
Report
Self-validating optimum currency areas
A currency area can be a self-validating optimal policy regime, even when monetary unification does not foster real economic integration and intra-industry trade. In our model, firms choose the optimal degree of exchange rate pass-through to export prices while accounting for expected monetary policies, and monetary authorities choose optimal policy rules while taking firms' pass-through as given. We show that there exist two equilibria, each of which defines a self-validating currency regime. In the first, firms preset prices in domestic currency and let prices in foreign currency be ...
Working Paper
Monetary Independence and Rollover Crises
This paper shows that the inability to use monetary policy for macroeconomic stabilization leaves a government more vulnerable to a rollover crisis. We study a sovereign default model with self-fulfilling rollover crises, foreign currency debt, and nominal rigidities. When the government lacks monetary autonomy, lenders anticipate that the government will face a severe recession in the event of a liquidity crisis, and are therefore more prone to run on government bonds. By contrast, a government with monetary autonomy can stabilize the economy and can easily remain immune to a rollover ...