On the Benefits of a Monetary Union: Does it Pay to Be Bigger?

69 Pages Posted: 6 Mar 2013

See all articles by Chiara Forlati

Chiara Forlati

Ecole Polytechnique Fédérale de Lausanne

Multiple version iconThere are 2 versions of this paper

Date Written: July 2012

Abstract

This paper revisits the question of the appropriate domain of a currency area using a New-Keynesian open economy model in which the world is split in two areas, each framed as a continuum of small open regions. We show that the adoption of a common currency like the euro can be beneficial for the members of the monetary union, since the spill-over effects within and across areas generated by the inflationary policies of the small open economies are likely to outweigh the costs of not tailoring monetary policy to country-specific shocks. We also show that while enlargement of the monetary union to another group of small open economies can bring about welfare gains for all countries involved, monetary integration of two large economies, such as the euro area and the U.S., will not. These findings can rationalize the process of the creation and enlargement of the eurozone.

Keywords: New Keynesian Open Economy Macroeconomics, Optimal Monetary Policy, Currency Area, Terms-of-Trade Externality

JEL Classification: E52, E61, F41

Suggested Citation

Forlati, Chiara, On the Benefits of a Monetary Union: Does it Pay to Be Bigger? (July 2012). Center for Fiscal Policy, EPFL, Chair of International Finance (CFI) Working Paper No. 03-2013, Available at SSRN: https://ssrn.com/abstract=2228610 or http://dx.doi.org/10.2139/ssrn.2228610

Chiara Forlati (Contact Author)

Ecole Polytechnique Fédérale de Lausanne ( email )

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Odyssea 1.04
1015 Lausanne, CH-1015
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