DP358 Monetary Interdependence under Alternative Exchange-Rate Regimes: A European Perspective

Author(s): Frederick van der Ploeg
Publication Date: November 1989
Keyword(s): EMS, EMU, Macroeconomic Interdependence, Monetary Policy, Policy Coordination
JEL(s): 430
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=358

This paper analyses and compares the effects of common demand and supply shocks on the setting of optimal monetary policies under a clean float, a managed exchange rate system (such as the EMS) and a monetary union, when welfare depends on unemployment and the cost of living. The results suggest that monetary union yields the smallest welfare loss and a float the greatest, and that the EMS gives France and Italy the opportunity to appreciate their currencies and reduce their welfare loss at the expense of Germany. The robustness of the results with respect to rational expectations and wage-price dynamics is verified with the aid of differential game theory and numerical simulation.