Hostname: page-component-77c89778f8-5wvtr Total loading time: 0 Render date: 2024-07-19T05:54:16.088Z Has data issue: false hasContentIssue false
  • English
  • Français

WHY JOIN A CURRENCY UNION? A NOTE ON THE IMPACT OF BELIEFS ON THE CHOICE OF MONETARY POLICY

Published online by Cambridge University Press:  18 August 2011

Federico Ravenna
Federico Ravenna*
Affiliation:
Institute of Applied Economics, HEC Montreal and University of California–Santa Cruz
*
Address correspondence to: Federico Ravenna, Institute of Applied Economics—HEC Montreal, 3000, Chemin de la Côte-Sainte-Catherine, Montréal, Québec H3T 2A7, Canada; e-mail: federico.ravenna@hec.ca.
Get access Rights & Permissions [Opens in a new window]

Abstract

We argue that a fixed exchange rate can be an optimal choice even if a policy maker could commit to the first-best monetary policy whenever the private sector's beliefs reflect incomplete information about the policy maker's dependability. This model implies that joining a currency area may be optimal for its impact not on the behavior of the policy maker, but on the beliefs of the private sector. Monetary policies are evaluated using a new Keynesian model of a small open economy solved under imperfect policy credibility. We quantify the minimum distance between announced policy and the private sector's beliefs that is necessary for a peg to perform better than an independent monetary policy when the policy maker can commit to the first-best policy.

Keywords

Monetary UnionSmall Open EconomyExchange Rate RegimesMonetary PolicyNominal RigiditiesCredibility
Type
Notes
Information
Macroeconomic Dynamics , Volume 16 , Issue 2 , April 2012 , pp. 320 - 334
Copyright
Copyright © Cambridge University Press 2011

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

REFERENCES

Backus, D. and Driffill, J. (1985) Rational expectations and policy credibility following a change in regime. Review of Economic Studies 52, 211–221.CrossRefGoogle Scholar
Barro, R. (1986) Reputation in a model of monetary policy with incomplete information. Journal of Monetary Economics 17, 3–20.CrossRefGoogle Scholar
Calvo, G. (1983) Staggered prices in a utility-maximizing framework. Journal of Monetary Economics 12, 383–398.CrossRefGoogle Scholar
Cukierman, A. and Liviatan, N. (1991) Optimal accommodation by strong policy makers under incomplete information. Journal of Monetary Economics 27, 99–127.CrossRefGoogle Scholar
Devereux, M. (2003) A macroeconomic analysis of EU accession under alternative monetary policies. Journal of Common Market Studies 41 (5), 941–964.CrossRefGoogle Scholar
Gali, Jordi and Monacelli, T. (2005) Monetary policy and exchange rate volatility in a small open economy. Review of Economic Studies 72 (3), 707–734.CrossRefGoogle Scholar
Giavazzi, F. and Pagano, M. (1988) The advantage of tying ones' hands. European Economic Review 32, 1055–1083.CrossRefGoogle Scholar
Monacelli, T. (2004) Into the Mussa puzzle: Monetary policy regimes and the real exchange rate in a small open economy. Journal of International Econmics 62, 192–217.Google Scholar
Ravenna, F. and Natalucci, F. (2008) Monetary policy choice in emerging markets: The case of high productivity growth. Journal of Money, Credit and Banking 40 (2–3), 243–271.CrossRefGoogle Scholar
Wieland, V. (2000) Learning-by-doing and the value of optimal experimentation. Journal of Economic Dynamics and Control 24, 501–534.CrossRefGoogle Scholar