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Journal of Economic Integration 2002 March;17(1) :104-132.
Should Small Countries Join an Existing Monetary Union ?

George M. von Furstenberg David P. Teolis 

Fordham University
General Motors Corporation
Copyright ©2002 Journal of Economic Integration
We explore the welfare consequences of the alternative monetary and exchange-rate regimes still available to the small country in open international financial markets in view of the optimum monetary policy that the large country adopts for itself. Both economies are based on nominal wage contracts with employment determined by the demand for labor under the contract terms. Reacting to movement in contemporaneously observable price variables, the monetary authorities of the large country, and of the small country under floating, aim to keep labor on its supply curve in the face of IS and LM shocks to aggregate demand, and shocks to aggregate supply. With monetary union, the small country trades discretionary monetary policy for greater stability in real exchange rates and insulation from its own idiosyncratic money supply and demand disturbances. The relative welfare costs of the different regimes for the small country are modeled and deduced from researched parameter values. The result is that there can be a stabilization rationale for accession to a monetary union except at low values of the correlations of like types of shocks for the large and small country.
Keywords: M
1. Goodfriend, Marvin (1987), "Interest-Rate Smoothing and Price Level Trend Stationarity," Journal of Monetary Economics 19(3), 335-348.
2. Taylor, John B. (1986), "New Econometric Approaches to Stabilization Policy in Stochastic Models of Macroeconomic Fluctuations," in Zvi Griliches and Michael D. Intriligator, eds., Handbook of Econometrics, Vol. III. Amsterdam: North-Holland, 1997-2055.
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Financial Heterogeneity in a Monetary Union  2013 September;28(3)
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