Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/222336 
Year of Publication: 
2020
Series/Report no.: 
ECONtribute Discussion Paper No. 010
Publisher: 
University of Bonn and University of Cologne, Reinhard Selten Institute (RSI), Bonn and Cologne
Abstract: 
We analyze the political economy of monetary unification among countries with different quality of institutions. Countries with stronger institutions have lower public spending and better investment incentives, even under a stronger currency. Governments under weaker institutions spend more so must occasionally devalue. In a MU market prices and ows adjust quickly but institutional differences persist, so a diverse monetary union (DMU) has redistributive effects. The government in the weaker country expands spending, and investment may be reduced by the fiscal and common exchange rate effect. Strong country production benefits from the weaker currency but needs to offer fiscal support in a crisis. In equilibrium the required support is incentive compatible due to the devaluation gain. Some governments may join a DMU even if it depresses productive capacity to expand public spending. Even in a DMU beneficial for all countries, firms in weaker countries and savers in stronger countries may lose.
Subjects: 
Monetary unions
institutional quality
fiscal union
political economy
fiscaltransfers
JEL: 
O33
O47
D72
F33
F45
Document Type: 
Working Paper

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