Uncertainty Shocks in Currency Unions

35 Pages Posted: 23 Dec 2020

See all articles by Benjamin Born

Benjamin Born

Frankfurt School of Finance & Management

Gernot J. Müller

University of Tuebingen - Department of Economics

Johannes Pfeifer

University of Cologne

Date Written: December 2020

Abstract

Uncertainty shocks cause economic activity to contract and more so, if monetary policy is constrained by an effective lower bound on interest rates. In this paper, we investigate whether countries within currency unions are also particularly prone to suffer from the adverse effects of heightened uncertainty because they lack monetary independence. First, we estimate a Bayesian VAR on quarterly time series for Spain. We find that country-specific uncertainty shocks impact economic activity adversely. Second, we calibrate a DSGE model of a small open economy and show that it is able to account for the evidence. Finally, we show that currency-union membership strongly reduces the effects of uncertainty shocks because it anchors long-run expectations of the price level and thus alleviates precautionary price setting in the face of increased uncertainty.

JEL Classification: E44, F41

Suggested Citation

Born, Benjamin and Müller, Gernot J. and Pfeifer, Johannes, Uncertainty Shocks in Currency Unions (December 2020). CEPR Discussion Paper No. DP15579, Available at SSRN: https://ssrn.com/abstract=3753984

Benjamin Born (Contact Author)

Frankfurt School of Finance & Management ( email )

Adickesallee 32-34
Frankfurt am Main, 60322
Germany

Gernot J. Müller

University of Tuebingen - Department of Economics ( email )

Mohlstrasse 36
D-72074 Tuebingen, 72074
Germany

Johannes Pfeifer

University of Cologne ( email )

Albertus-Magnus-Platz
Cologne, 50923
Germany

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