The Behavioral Economics of Currency Unions: Economic Integration and Monetary Policy

32 Pages Posted: 24 May 2018 Last revised: 1 May 2020

See all articles by Akvile Bertasiute

Akvile Bertasiute

National Audit Office of Lithuania - Budget Policy Monitoring Department

Domenico Massaro

Catholic University of Milan; University of Amsterdam - CeNDEF

Matthias Weber

University of St. Gallen - School of Finance

Date Written: March 1, 2020

Abstract

We analyze different behavioral models of expectation formation in a multi-country New Keynesian currency union model. Our analyses yield the following robust results. First, economic integration is of crucial importance for the stability of the economic dynamics in a currency union. Second, when the economic dynamics are unstable, more activist monetary policy does not lead to stable economic dynamics. These findings have natural counterparts in the rational expectations version of the model: there, economic integration is crucial for the determinacy of the equilibrium and when the equilibrium is indeterminate, more activist monetary policy does not lead to a determinate equilibrium. In an application to euro area data, we find that the behavioral macroeconomic model outperforms its rational counterpart in terms of prediction performance.

Keywords: Behavioral Macroeconomics; Monetary Union; Currency Union; Determinacy of Equilibria; Reinforcement Learning

JEL Classification: E70, F45, E52, D84

Suggested Citation

Bertasiute, Akvile and Massaro, Domenico and Weber, Matthias, The Behavioral Economics of Currency Unions: Economic Integration and Monetary Policy (March 1, 2020). Journal of Economic Dynamics and Control, Vol. 112, 2020, Available at SSRN: https://ssrn.com/abstract=3169793 or http://dx.doi.org/10.2139/ssrn.3169793

Akvile Bertasiute

National Audit Office of Lithuania - Budget Policy Monitoring Department ( email )

Vilnius, 01113
Lithuania

Domenico Massaro

Catholic University of Milan ( email )

Largo Gemelli, 1
Via Necchi 9
Milan, MI 20123
Italy

University of Amsterdam - CeNDEF ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

Matthias Weber (Contact Author)

University of St. Gallen - School of Finance ( email )

Unterer Graben 21
St.Gallen, CH-9000
Switzerland

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