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Instability and trade in currency areas

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  • Alonso, Alberto
  • Guzmán, Vanesa

Abstract

We present a model of a currency area in which labor markets of country members are isolated but there is trade among these countries. When a country experiences a negative (resp. positive) shock, inflation goes down (up). This causes two effects. On the one hand the real interest rate of this country increases (decreases). On the other hand the goods produced in this country become more (less) competitive. We show that the stability of the system depends on several factors, including a large competitive effect, how inflation expectations are formed and fiscal policy. In general, stability requires a trade-off between the rationality of expectations and budget balance.

Suggested Citation

  • Alonso, Alberto & Guzmán, Vanesa, 2004. "Instability and trade in currency areas," UC3M Working papers. Economics we043010, Universidad Carlos III de Madrid. Departamento de Economía.
    • Handle: RePEc:cte:werepe:we043010
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    References listed on IDEAS

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    1. Tobin, James, 1975. "Keynesian Models of Recession and Depression," American Economic Review, American Economic Association, vol. 65(2), pages 195-202, May.
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    More about this item

    JEL classification:

    • F15 - International Economics - - Trade - - - Economic Integration
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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