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Monday, 30 July 2018
15.00 PM
Tinbergen Institute Amsterdam, room 1.60TIA room 1.60Netherlands
Erasmus University Rotterdam

This paper studies the political economy of monetary unification among countries that differ in their quality of institutions. Countries with better public governance have greater fiscal accountability, lower taxes, lower interest rates, a stronger currency and more private investment. If fiscal accountability is low, a country needs to occasionally resort to a competitive devaluation to ensure solvency. We show that for both the institutionally stronger and weaker country monetary unification can be beneficial. Monetary unification increases social welfare in an institutionally strong country by weakening its currency, increasing the incentives to invest, while it also benefits the weak country by lowering borrowing costs and mitigating binding sovereign debt constraints. However, institutional quality is persistent. Since monetary unification takes away the devaluation possibility, ensuring the stability of the monetary union may require a re-distributive monetary transfer.