Establishing a Monetary Union

32 Pages Posted: 18 Jan 1999 Last revised: 11 Oct 2010

See all articles by Russell Cooper

Russell Cooper

University of Texas at Austin - Department of Economics; National Bureau of Economic Research (NBER)

Hubert Kempf

Ecole Normale Superieure de Cachan (ENS)

Date Written: November 1998

Abstract

This paper explores the gains to monetary union. We consider a two-country overlapping generations model. Agents work when young and have random tastes over the composition (domestic vs. foreign goods) of old age consumption. In equilibrium, governments require that local currency be used for transactions as a means of creating a base for seignorage. Thus agents hold multiple currencies to deal with uncertainty in their optimal consumption bundles. We argue that this equilibrium is Pareto dominated by a monetary union, in which there is a single currency and a strong central bank that optimally chooses zero inflation. As suggested by the European Commission's 1990 report, monetary union reduces the inefficiencies created by multiple currencies and leads to price stability. Finally, we argue this Pareto superior outcome cannot be achieved without cooperation of the two governments.

Suggested Citation

Cooper, Russell W. and Kempf, Hubert, Establishing a Monetary Union (November 1998). NBER Working Paper No. w6791. Available at SSRN: https://ssrn.com/abstract=139573

Russell W. Cooper (Contact Author)

University of Texas at Austin - Department of Economics ( email )

Austin, TX 78712
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Hubert Kempf

Ecole Normale Superieure de Cachan (ENS) ( email )

61 avenue du président Wilson
Cachan, Paris 94235
France

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