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Establishing a Monetary Union

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  • Russell Cooper
  • Hubert Kempf

Abstract

This paper explores the gains to monetary union. We consider a two-country overlapping generations model. Agents work when young and have random tastes over the composition (domestic vs. foreign goods) of old age consumption. In equilibrium, governments require that local currency be used for transactions as a means of creating a base for seignorage. Thus agents hold multiple currencies to deal with uncertainty in their optimal consumption bundles. We argue that this equilibrium is Pareto dominated by a monetary union, in which there is a single currency and a strong central bank that optimally chooses zero inflation. As suggested by the European Commission's 1990 report, monetary union reduces the inefficiencies created by multiple currencies and leads to price stability. Finally, we argue this Pareto superior outcome cannot be achieved without cooperation of the two governments.

Suggested Citation

  • Russell Cooper & Hubert Kempf, 1998. "Establishing a Monetary Union," NBER Working Papers 6791, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:6791
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    References listed on IDEAS

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    Cited by:

    1. Russell W. Cooper & Hubert Kempf, 2001. "Dollarization and the conquest of hyperinflation in divided societies," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 25(Sum), pages 3-12.
    2. Holod, Dmytro & Reed, Robert III, 2004. "Regional spillovers, economic growth, and the effects of economic integration," Economics Letters, Elsevier, vol. 85(1), pages 35-42, October.

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    More about this item

    JEL classification:

    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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