Welfare Reversals in a Monetary Union
GATE Working Paper Series No. 1342
46 Pages Posted: 8 Jan 2014
Date Written: November 2013
We show that welfare can be lower under complete financial markets than under autarky in a monetary union with home bias, sticky prices and asymmetric shocks. Such a monetary union is a second-best environment in which the structure of financial markets affects risk-sharing but also shapes the dynamics of inflation rates and the welfare costs from nominal rigidities. Welfare reversals arise for a variety of empirically plausible degrees of price stickiness when the Marshall-Lerner condition is met. These results carry over a model with active fiscal policies, and hold within a medium-scale model, although to a weaker extent.
Keywords: Monetary Union, Financial Markets Incompleteness, Sticky Prices, Fiscal and Monetary Policy
JEL Classification: E32, E63, F32, F41, F42
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