Hostname: page-component-78c5997874-ndw9j Total loading time: 0 Render date: 2024-11-11T15:33:47.472Z Has data issue: false hasContentIssue false
  • English
  • Français

OPTIMAL MONETARY AND FISCAL POLICY IN A CURRENCY UNION WITH FRICTIONAL GOODS MARKETS

Published online by Cambridge University Press:  04 November 2019

Pedro Gomis-Porqueras  and
Cathy Zhang
Pedro Gomis-Porqueras
Affiliation:
Deakin University
Cathy Zhang*
Affiliation:
Purdue University
*
Address correspondence to: Cathy Zhang, Department of Economics, Krannert School of Management, Purdue University, 100 South Grant Street, West Lafayette, IN 47907, USA. e-mail: cmzhang@purdue.edu.
Get access Rights & Permissions [Opens in a new window]

Abstract

We develop an open economy model of a currency union with frictional goods markets and endogenous search decisions to study optimal monetary and fiscal policy. Households finance consumption with a common currency and can search for locally produced goods across regions that differ in their market characteristics. Equilibrium is generically inefficient due to regional spillovers from endogenous search decisions. While monetary policy alone cannot correct this distortion, fiscal policy can help improve allocations by taxing or subsidizing production at the regional level. When households of only one region can search, optimal policy entails a deviation from the Friedman rule and a production subsidy (tax) if there is underinvestment (overinvestment) in search decisions. Optimal policy when households from both region search requires the Friedman rule and zero production taxes in both regions.

Keywords

Currency UnionsSearch FrictionsOptimal Monetary and Fiscal Policy
Type
Articles
Information
Macroeconomic Dynamics , Volume 25 , Issue 7 , October 2021 , pp. 1726 - 1754
Copyright
© Cambridge University Press 2019

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.)

Footnotes

We thank the Associate Editor and two anonymous referees for their comments and advice. Jacklyn Buhrmann, Benjamin Raymond, and Wumian Ashley Zhao provided excellent research assistance. The authors declare no relevant or material financial interests that relate to the research described in this paper.

References

REFERENCES

Baldwin, R. and Taglioni, D. (2007) Trade Effects of the Europe. Journal of Economic Integration 22(4), 780–818.10.11130/jei.2007.22.4.780CrossRefGoogle Scholar
Beetsma, R. and Uhlig, H. (1999) An analysis of the stability and growth pact. Economic Journal 109, 546–71.10.1111/1468-0297.00462CrossRefGoogle Scholar
Beetsma, R. and Jensen, H. (2005) Monetary and fiscal policy interactions in a micro-founded model of a monetary union. Journal of International Economics 67(2), 320–352.10.1016/j.jinteco.2005.03.001CrossRefGoogle Scholar
Berentsen, A., Shi, S. and Rocheteau, G. (2007) Friedman meets Hosios: On efficiency in search models of money. Economic Journal 46, 495–522.Google Scholar
Bignon, V., Breton, R. and Rojas Breu, M. (2015) Monetary Union with A Single Currency and Imperfect Credit Market Integration. Working Papers: No. 541, Banque de France.10.2139/ssrn.2577824CrossRefGoogle Scholar
Branch, B., Petrosky-Nadeau, N. and Rocheteau, G. (2016) Financial frictions, the housing markets and unemployment. Journal of Economic Theory 64(C), 101–135.10.1016/j.jet.2015.07.008CrossRefGoogle Scholar
Chang, B. (2012) A Search Theory of Sectoral Reallocation. Working Paper.10.2139/ssrn.1748623CrossRefGoogle Scholar
Chari, V. V. and Kehoe, P. J. (1993) Sustainable plans and mutual default. Review of Economic Studies 60, 175–195.10.2307/2297817CrossRefGoogle Scholar
Chari, V. V. and Kehoe, P. J. (2008) Time inconsistency and free-riding in a monetary union. Journal of Money, Credit and Banking 40(7), 1329–1356.10.1111/j.1538-4616.2008.00162.xCrossRefGoogle Scholar
Corsetti, G. and Pesenti, P. (2007) The Simple Geometry of Transmission and Stabilization in Closed and Open Economies. NBER International Seminar on Macroeconomics 65–116.10.1086/653991CrossRefGoogle Scholar
Cooper, R. and Kempf, H. (2004) Overturning Mundell: Fiscal policy in a monetary union. Review of Economic Studies 71, 371–396.10.1111/0034-6527.00288CrossRefGoogle Scholar
Gali, J. and Monacelli, T. (2008) Optimal monetary and fiscal policy in a currency union. Journal of International Economics 76(1), 116–132.10.1016/j.jinteco.2008.02.007CrossRefGoogle Scholar
Gomis-Porqueras, P. and Peralta-Alva, A. (2010) Optimal monetary and fiscal policies in a search theoretic model of monetary exchange. European Economic Review 54(3), 331–344.10.1016/j.euroecorev.2009.08.007CrossRefGoogle Scholar
Gomis-Porqueras, P., Julien, B. and Wang, C. (2013) Optimal monetary and fiscal policies in a search-theoretic model of money and unemployment. Macroeconomic Dynamics 17(06), 1330–1354.10.1017/S1365100512000016CrossRefGoogle Scholar
Gomis-Porqueras, P., Kam, T. and Waller, C. (2017) Nominal exchange rate determinacy under the threat of currency counterfeiting. American Economic Journal: Macroeconomics 9(2), 256–273.Google Scholar
Head, K. and Mayer, T. (2014) Gravity equations: Workhorse, toolkit, and cookbook. In: Gopinath, G., Helpman, E. and Rogoff, K. (eds.), Handbook of International Economics, Chapter 3, vol. 4, pp. 131–195. Elsevier.Google Scholar
Herrenbreuck, L. (2015) Optimal Monetary Policy, Currency Unions, and the Eurozone Divergence. Working Paper.Google Scholar
Hiraguchi, R. and Kobayashi, K. (2014) On the optimality of the Friedman rule in a new monetarist model. Economics Letters 125(1), 57–60.10.1016/j.econlet.2014.08.002CrossRefGoogle Scholar
Kalai, E. (1977) Proportional solutions to bargaining situations: Interpersonal utility comparisons. Econometrica 45, 1623–1630.10.2307/1913954CrossRefGoogle Scholar
Kenen, P. (1969) The optimum currency area: An eclectic view. In: Mundell, R. A. and Swoboda, A. K. (eds.), Monetary Problems of the International Economy, Chicago: University of Chicago Press.Google Scholar
Kneller, R. and Pisu, M. (2011) Barriers to exporting: What are they and who do they matter to? The World Economy 34(6), 893–930.10.1111/j.1467-9701.2011.01357.xCrossRefGoogle Scholar
Krolikowski, P. and McCallum, A. (2017) Goods-market frictions and international trade. FRB International Finance Discussion Paper No. 1207.10.17016/IFDP.2017.1207CrossRefGoogle Scholar
Lagos, R. and Rocheteau, G. (2005) Inflation, output and welfare. International Economic Review 46, 495–522.10.1111/j.1468-2354.2005.00331.xCrossRefGoogle Scholar
Lagos, R. and Wright, R. (2005) A unified framework for monetary theory and policy analysis. Journal of Political Economy 113(3), 463–484.10.1086/429804CrossRefGoogle Scholar
Lagos, R., Rocheteau, G. and Wright, R. (2017) Liquidity: A new monetarist perspective. Journal of Economic Literature 55(2), 371–440.10.1257/jel.20141195CrossRefGoogle Scholar
Lehmann, E. (2012) A search model of unemployment and inflation. Scandinavian Journal of Economics 114(1), 245–266.10.1111/j.1467-9442.2011.01670.xCrossRefGoogle Scholar
Rauch, J. (1996) Networks versus markets in international trade. NBER Working Paper No. 5617.10.3386/w5617CrossRefGoogle Scholar
Rocheteau, G. and Nosal, E. (2017) Money, Payments, and Liquidity, Cambridge, MA: MIT Press Books.10.7551/mitpress/10518.001.0001CrossRefGoogle Scholar
Rocheteau, G. and Wright, R. (2009) Inflation and Welfare in Models with Trading Frictions, Monetary Policy in Low Inflation Economies, Cambridge University Press.Google Scholar
Rocheteau, G. and Wright, R. (2005) Money in search equilibrium, in competitive equilibrium and in competitive search equilibrium. Econometrica 73(1), 175–202.10.1111/j.1468-0262.2005.00568.xCrossRefGoogle Scholar
Rose, A. (2000) One money, one market: The effect of common currencies on trade. Economic Policy 15(30), 7–46.10.1111/1468-0327.00056CrossRefGoogle Scholar
Rose, A. and van Wincoop, E. (2001) National money as a barrier to international trade: The real case for currency union. American Economic Review Papers and Proceedings 91(2), 386–390.10.1257/aer.91.2.386CrossRefGoogle Scholar
Santos, S. and Tenreyro, S. (2006) The Log of gravity. Review of Economics and Statistics 88, 641–658.Google Scholar
Zhang, C. (2014) An information-based theory of international currency. Journal of International Economics 93(2), 286–301.10.1016/j.jinteco.2014.04.005CrossRefGoogle Scholar