Monetary policy in heterogeneous currency unions: Reections based on a micro-founded model of Optimum Currency Areas

The adoption of a common currency has fostered European economic integration and provided many European countries with an e¢ cient tool to reduce in‡ation and …nancial volatility. It is well understood, however, that a single monetary policy also opens a stabilization gap at national level, relative to an ideal benchmark in which output gaps and marginal costs are e¢ ciently stabilized in each region of the monetary union. Recent monetary theory has stressed e¢ ciency costs of in‡ation dispersion in the presence of nominal rigidities. In a single currency area, some in‡ation dispersion will be the unavoidable costs of relative price adjustment across sectors and regions. In this text, I argue that the same class of models highlighting the costs of in‡ation dispersion also points to a di¤erent cost of ine¢ cient stabilization, consisting of a wedge between average output and its e¢ cient level. The adoption of a single currency does not a¤ect the rate of growth of GDP, but may a¤ect the average level of activity, as a stabilization gap at national level exacerbates monopolistic distortions. Moreover, convergence in growth rates is not necessarily an indicator that heterogeneity in business cycle is falling. A micro-founded OCA model unveils the possibility that monetary unions be self-validating optimal monetary regimes, whereas economic costs due to heterogeneity persist even if growth rates converge completely after monetary uni…cation. I conclude with a brief discussion of other dimensions of other possible welfare losses in a monetary union, including in‡ation dispersion, suboptimal level of investment, market segmentation, and ine¢ cient provision of public goods –which provide interesting and potentially important directions for future research.