DP5615 Joining the European Monetary Union - Comparing First and Second Generation Open Economy Models

Author(s): Vo Phuong Mai Le, Patrick Minford
Publication Date: April 2006
Keyword(s): asymmetry, monetary union, multi-country model, representative agent model, wage rigidity
JEL(s): E42, F41, F42
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5615

We log-linearise the Dellas and Tavlas (DT) model of monetary union and solve it analytically. We find that the intuition of optimal currency analysis of DT's second generation open economy model is essentially the same as that of first generation models. Monetary union results in no welfare loss if its member states are symmetric. However, asymmetry causes loss in welfare both due to the failure of the union policy to deal suitably with a country's asymmetric shocks and due to an active monetary policy by union in pursuit of its distinct objectives. The asymmetry in DT is largely due to the differing wage rigidities across countries.