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The political economy of currency unions

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  • Kai Arvai

    (Banque de France - Banque de France - Banque de France)

Abstract

How can monetary and fiscal policy sustain a currency union when member states have an exit option? This paper derives an interest rate rule that features state-dependent country weights with which the central bank can prevent a break-up. A simulation reveals that this policy rule lacks firepower and can only extend the lifetime of the union for a while. While monetary policy is more potent in unions with more member states or setups with local currency pricing, it is still true that even a simple fiscal union with lump-sum transfers is better suited to prevent a break-up. Environments with lower risk sharing, the ZLB or wage rigidity make monetary policy even less effective.

Suggested Citation

  • Kai Arvai, 2024. "The political economy of currency unions," Post-Print halshs-04948365, HAL.
    • Handle: RePEc:hal:journl:halshs-04948365
    DOI: 10.1016/j.jinteco.2024.103991
    as

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