Currency Areas and International Assistance
CORE Discussion Paper No. 2007/52
28 Pages Posted: 30 Aug 2007
Date Written: July 2007
This paper considers a simple stochastic model of international trade with three countries. Two of the tree countries are in an economic union. Comparisons are made between equilibrium welfare for these two countries under fixed and flexible exchange rate regimes. Within the model it is shown that flexible exchange rate regimes generate greater welfare. However, we then consider comparisons of welfare when the two countries also engage in some international assistance in order to share risk. Such risk-sharing is limited by enforcement constraints of cross border assistance. It is shown that taking into account limited commitment risk-sharing fixed exchange rates or currency areas can dominate flexible exchange rate regimes reversing the previous result.
Keywords: Monetary Union, Currency Areas, Fiscal Federalism, Limited Commitment, Mutual Insurance
JEL Classification: F12, F15, F31, F33
Suggested Citation: Suggested Citation