Seminars

The Inherent Benefit of Monetary Unions

Economics & Decision Sciences

Speaker: Tommaso Monacelli
Bocconi

30 March 2016 - T004 - From 2:00 pm to 3:00 pm

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The desirability of flexible exchange rates is a central tenet in international macro-
economics. We show that, with forward-looking staggered pricing, this result crucially
depends on the monetary authority's ability to commit. Under full commitment, flex-
ible exchange rates generally dominate a monetary union (or fxed exchange rate)
regime. Under discretion, this result is overturned: a monetary union dominates flex-
ible exchange rates. By fixing the nominal exchange rate, a benevolent monetary au-
thority finds it welfare improving to tradeoff efficiency in the adjustment of the terms of
trade, in order to improve on its ability to manage private sector's expectations. Thus,
fixed exchange rate-induced inertia in the terms of trade is a cost under commitment,
whereas it is a benefit under discretion, for it acts like a commitment device.

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