A Model of An Optimum Currency Area
This paper investigates the circumstances under which it is beneficial to participate in a currency area. A two-country monetary model of trade with nominal rigidities encompasses the real and monetary arguments suggested by the optimum currency area literature: correlation of real shocks, international factor mobility, fiscal adjustment, openness, difference in national inflationary biases, correlation of monetary shocks, and benefits of a single currency. The effect of openness on the net benefits is ambiguous, contrary to the usual argument that more open economies are better candidates for a currency area. Countries do not necessarily agree on whether a given currency union should be created.
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II The Model
III Shocks and Adjustment
IV CostBenefit Analysis of A Currency Union
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adjustment to shocks adoption Aggregate Demand argument asymmetric Bayoumi Blanchard capital mobility correlation between monetary correlation of real correlation of shocks cost-beneﬁt analysis currency area literature currency union deﬁned degree of openness deutsche mark domestic monetary shocks effect elimination Equation European Monetary European Union exchange rate regime ﬁilly ﬁnd ﬁrms ﬁscal federalism ﬁscal policy ﬁscal rule ﬁscal tool ﬁxed exchange rate ﬂexible exchange rates ﬂexible rates ﬂuctuations foreign monetary shocks framework full employment home country increase inﬂation and unemployment inﬂation levels inﬂationary bias initial equilibrium instrument of adjustment international labor mobility investigate labor force migration monetary policy money market money stocks money supply Mundell net beneﬁts nominal income nominal rigidities nontraded open economies optimum currency area participation percentage Phillips curve proﬁts real shocks relative price returns to scale Section I.B short run adjustment single currency speciﬁc supply shocks terms of inﬂation tradables trade shocks transaction costs variability wages