Creator: Cooper, Russell and Kempf, Hubert Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 311 Abstract:
Central to ongoing debates over the desirability of monetary unions is a supposed trade-off, outlined by Mundell : 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 indeed a monetary union will not be welfare improving if the correlation of national shocks is too low. However, fiscal interventions by national governments, combined with a central bank that has the ability to commit to monetary policy, overturn these results. In equilibrium, such a monetary union will be welfare improving for any correlation of shocks.
Keyword: Unemployment, Public assistance programs, Monetary unions, Central banks, Income taxes, Currency, and Stabilization policies