Working paper No. 102
By Andrew Brigden and Charles Nolan
We do two things in this paper. First, we look at some simple models of monetary decision-making in a monetary union and ask how much more variable a country’s output and inflation is likely to be if it joins the union. We answer this analytically and then go on to ‘calibrate’ the simple model. The model has few structural equations, but it is useful in allowing us to examine how the variability of output and inflation are likely to change as key parameters change. Our conclusions, in this respect, are likely to be sensitive to model specification. However, we also identify a second-best issue concerning the optimal make-up of the monetary union which is likely to be more robust: namely that only when all members of the union have the same structural parameter values (and shocks are perfectly correlated) will it be optimal for a new member to have these same structural parameter values.