On Financial Markets Incompleteness, Price Stickiness, and Welfare in a Monetary Union
CIRPEE Working Paper 07-48
29 Pages Posted: 24 Dec 2007
Date Written: December 2007
In this paper, we measure the welfare costs/gains associated with financial market incompleteness in a monetary union. To do this, we build on a two-country model of a monetary union with sticky prices subject to asymmetric productivity shocks. For most plausible values of price stickiness, we show that asymmetric shocks under incomplete financial markets give rise to a lower volatility of national inflation rates, which proves welfare improving with respect to the situation of complete financial markets. The corresponding welfare gains are equivalent to an average increase of 1.8 percent of permanent consumption.
Keywords: Monetary union, asymmetric shocks, price stickiness, financial market incompleteness, welfare
JEL Classification: E51, E58, F36, F41
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