Management of a Common Currency

31 Pages Posted: 29 Jun 2010 Last revised: 29 Dec 2022

See all articles by Alessandra Casella

Alessandra Casella

Columbia University - Graduate School of Arts and Sciences, Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Jonathan S. Feinstein

Yale School of Management

Date Written: October 1988

Abstract

This paper presents a simple general equilibrium model of two countries using a common currency. The goal is to study how the monetary arrangement influences the optimum financing of a public good. If the two countries are allowed to print the common currency autonomously, they will finance their fiscal spending with money, oversupplying the public good and crowding out the private sector. The possibility to export part of the inflation creates a distortion in incentives such the resulting equilibrium is strictly welfare inferior to the one prevailing under flexible exchange rates. If the management of the common currency is deferred to an international central bank, each country will try to use domestic policy variables (taxes) to manipulate in its favor the actions of the bank. With no independent domestic taxes, the bank can improve welfare. However, its policies naturally support the larger country, and to induce the smaller one to participate requires giving it a disproportionately large, politically unrealistic, representation in the bank's objective function.

Suggested Citation

Casella, Alessandra and Feinstein, Jonathan S., Management of a Common Currency (October 1988). NBER Working Paper No. w2740, Available at SSRN: https://ssrn.com/abstract=1632149

Alessandra Casella (Contact Author)

Columbia University - Graduate School of Arts and Sciences, Department of Economics ( email )

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Jonathan S. Feinstein

Yale School of Management ( email )

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