Common Currencies Versus Monetary Independence

43 Pages Posted: 20 Aug 2002

See all articles by Thomas F. Cooley

Thomas F. Cooley

New York University - Leonard N. Stern School of Business; National Bureau of Economic Research (NBER)

Vincenzo Quadrini

University of Southern California - Marshall School of Business - Finance and Business Economics Department; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Date Written: June 2002

Abstract

We study the optimal monetary policy in a two-country open-economy model under two monetary arrangements: (a) multiple currencies controlled by independent policy-makers; (b) common currencies controlled by a centralized policy-maker. Our findings suggest that: (i) Monetary policy competition leads to higher long-term inflation and interest rates with large welfare losses; (ii) The inflation bias and the consequent losses are larger when countries are unable to commit to future policies; (iii) in both cases, the welfare losses from higher inflation dominates the welfare costs of losing the ability to react optimally to business cycle shocks. Therefore, the coordination of policies implicit in the adoption of a common currency or dollarization has positive welfare consequences.

Keywords: Optimal monetary policy, international coordination, common currency

JEL Classification: E00, E50, F00

Suggested Citation

Cooley, Thomas F. and Quadrini, Vincenzo, Common Currencies Versus Monetary Independence (June 2002). CEPR Discussion Paper No. 3436. Available at SSRN: https://ssrn.com/abstract=323392

Thomas F. Cooley (Contact Author)

New York University - Leonard N. Stern School of Business ( email )

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National Bureau of Economic Research (NBER)

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Vincenzo Quadrini

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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