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Management of a Common Currency

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  • Alessandra Casella
  • Jonathan Feinstein

Abstract

This paper presents a simple general equilibrium model of two countries using a common currency. The goal is to study how the monetary arrangement influences the optimum financing of a public good. If the two countries are allowed to print the common currency autonomously, they will finance their fiscal spending with money, oversupplying the public good and crowding out the private sector. The possibility to export part of the inflation creates a distortion in incentives such the resulting equilibrium is strictly welfare inferior to the one prevailing under flexible exchange rates. If the management of the common currency is deferred to an international central bank, each country will try to use domestic policy variables (taxes) to manipulate in its favor the actions of the bank. With no independent domestic taxes, the bank can improve welfare. However, its policies naturally support the larger country, and to induce the smaller one to participate requires giving it a disproportionately large, politically unrealistic, representation in the bank's objective function.

Suggested Citation

  • Alessandra Casella & Jonathan Feinstein, 1988. "Management of a Common Currency," NBER Working Papers 2740, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:2740
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    1. Alberto Alesina, 1987. "A Positive Theory of Fiscal Deficits and Government Debt in a Democracy," UCLA Economics Working Papers 435, UCLA Department of Economics.
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    Cited by:

    1. Emmanuel Farhi & Iván Werning, 2017. "Fiscal Unions," American Economic Review, American Economic Association, vol. 107(12), pages 3788-3834, December.
    2. Barry Eichengreen, 1991. "Designing a Central Bank for Europe: A Cautionary Tale From the Early Years of the Federal Reserve System," NBER Working Papers 3840, National Bureau of Economic Research, Inc.
    3. Casella, Alessandra, 1992. "Participation in a Currency Union," American Economic Review, American Economic Association, vol. 82(4), pages 847-863, September.
    4. Patrick Artus, 1992. "Passage à l'union économique et monétaire en Europe : effets sur la croissance et les politiques budgétaires," Économie et Prévision, Programme National Persée, vol. 106(5), pages 123-137.
    5. Russell Cooper & Hubert Kempf, 1998. "Establishing a Monetary Union," NBER Working Papers 6791, National Bureau of Economic Research, Inc.
    6. Aizenman, Joshua, 1992. "Competitive Externalities and the Optimal Seigniorage," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 24(1), pages 61-71, February.
    7. Joshua Aizenman & Peter Isard, 1990. "Externalities, Incentives, and Economic Reforms," NBER Working Papers 3395, National Bureau of Economic Research, Inc.
    8. Guillaume Cheikbossian, 2001. "When a Monetary Union Fails: A Parable," Open Economies Review, Springer, vol. 12(2), pages 181-195, April.
    9. Dominique Hachette & Fernando Ossa & Francisco Rosende, 1996. "Aspectos Monetarios y Macroeconómicos de la Integración," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 33(98), pages 153-183.
    10. Richard Pomfret, 2003. "Formation and Dissolution of Monetary Unions: Evidence from Europe, and Lessons for Elsewhere," School of Economics and Public Policy Working Papers 2003-03, University of Adelaide, School of Economics and Public Policy.

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