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On financial markets incompleteness, price stickiness and welfare in a monetary union

Author

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  • Aurélien Eyquem

    (CREM - Centre de recherche en économie et management - UNICAEN - Université de Caen Normandie - NU - Normandie Université - UR - Université de Rennes - CNRS - Centre National de la Recherche Scientifique)

  • Stéphane Auray

    (GREMARS - Groupe de Recherches Modélisation Appliquée à la Recherche en Sciences Sociales - Université de Lille, Sciences Humaines et Sociales)

Abstract

The paper builds a two-country model of a monetary union with home bias and price stickiness. Incompleteness of financial asset markets is allowed. In this environment, we derive the solution for optimal behavior by the monetary policymaker and show that welfare can be higher under incomplete markets than under complete markets. The argument is a second-best one. In a monetary union with equal nominal rigidity across countries, optimal monetary policy stabilizes aggregate, union-wide inflation, but cannot fully stabilize the country-level inflation rates. Market incompleteness results in less volatility of the terms of trade because part of the adjustment goes through the current account), and hence less volatile national inflation rates. Through this channel, welfare ends up being higher under incomplete markets. These results are also robust when nominal rigidity differs across countries and when the form of the monetary policy is modified.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Aurélien Eyquem & Stéphane Auray, 2008. "On financial markets incompleteness, price stickiness and welfare in a monetary union," Post-Print halshs-00325987, HAL.
    • Handle: RePEc:hal:journl:halshs-00325987
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    References listed on IDEAS

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    More about this item

    Keywords

    monetary union; asymmetric shocks; price stickiness; financial market incompleteness; welfare;
    All these keywords.

    JEL classification:

    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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