On Financial Markets Incompleteness, Price Stickiness, and Welfare in a Monetary Union

In this paper, we measure the welfare costs/gains associated with financial market incompleteness in a monetary union. To do this, we build on a two-country model of a monetary union with sticky prices subject to asymmetric productivity shocks. For most plausible values of price stickiness, we show that asymmetric shocks under incomplete financial markets give rise to a lower volatility of national inflation rates, which proves welfare improving with respect to the situation of complete financial markets. The corresponding welfare gains are equivalent to an average increase of 1.8% of permanent consumption.Monetary union, Asymmetric shocks, Price stickiness, Financial market incompleteness, welfare

On financial markets inclompleteness, price stickyness and welfare in a monetary union ?

In this paper, we measure the welfare costs/gains associated with financial market incompleteness in a monetary union. To do this, we build on a two-country model of a monetary union with sticky prices subject to asymmetric productivity shocks. For most plausible values of price stickiness, we show that asymmetric shocks under incomplete financial markets give rise to a lower volatility of national infation rates, which proves welfare improving with respect to the situation of complete financial markets. The corresponding welfare gains are equivalent to an average increase of 1.8% of permanent consumption.monetary union, asymmetric shocks, price stickiness, financial market incompleteness, welfare

Endogenous Entry, International Business Cycles, and Welfare

Working paper GATE 2011-14This paper examines if taking into account changes in the number of producers, or equivalently changes in the product variety space over the business cycle, helps to understand and replicate international business cycle facts. To this end, we develop a two-country model in which the economy is driven by real and monetary policy shocks. If it is characterized by an endogenous number of firms and varieties, sticky prices and financial markets incompleteness. We show that these features are crucial to reproduce international business cycle statistics. We also evaluate the welfare implications of various monetary policies and highlight the importance for monetary policymakers to respond moderately to output fluctuations

Welfare Reversals in a Monetary Union

We show that welfare can be lower under complete financial markets than under autarky in a monetary union with home bias, sticky prices and asymmetric shocks. Such a monetary union is a second-best environment in which the structure of financial markets affects risk-sharing but also shapes the dynamics of inflation rates and the welfare costs from nominal rigidities. Welfare reversals arise for a variety of empirically plausible degrees of price stickiness when the Marshall-Lerner condition is met. These results carry over a model with active fiscal policies, and hold within a medium-scale model, although to a weaker extent

The Welfare Gains of Trade Integration in the European Monetary Union

This paper evaluates the welfare gains arising from a deeper trade integration in the European Monetary Union. To do this, the European Monetary Union is represented in a realistic way by an intertemporal general equilibrium model with incomplete financial markets, sticky prices and home bias both in private consumption and production. The model is estimated and globally not rejected by the data. Two main results emerge : (i) an increase in vertical (intermediate goods) trade implies welfare gains while (ii) an increase in horizontal trade implies welfare losses.trade integration, inflation differentials, welfare analysis, optimal currency areas

Government Spending, Monetary Policy, and the Real Exchange Rate

A robust prediction across a wide range of open-economy macroeconomic models is that an unanticipated increase in public spending in a given country appreciates it currency in real terms. This result, however, contradicts the findings of a number of recent empirical studies, which instead document a signifi...cant and persistent depreciation of the real exchange rate following an expansionary government spending shock. In this paper, we rationalize the findings of the empirical literature by proposing a small-open-economy model that features three key ingredients : incomplete and imperfect international financial markets, sticky prices, and a not-too-aggressive monetary policy. The model predicts that in response to an unexpected increase in public expenditures, the risk-adjusted long-term real interest rate falls, causing the real exchange rate to depreciate. We establish this result both analytically, within a special version of the model, and numerically for the more general case.Real exchange rate; public spending shocks; small open economy; sticky prices; monetary policy

Endogenous Entry, International Business Cycles, and Welfare

This paper examines if taking into account changes in the number of producers, or equivalently changes in the product variety space over the business cycle, helps to understand and replicate international business cycle facts. To this end, we develop a two-country model in which the economy is driven by real and monetary policy shocks. If it is characterized by an endogenous number of firms and varieties, sticky prices and financial markets incompleteness. We show that these features are crucial to reproduce international business cycle statistics. We also evaluate the welfare implications of various monetary policies and highlight the importance for monetary policymakers to respond moderately to output fluctuations.International business cycles; Endogenous entry; Financial markets incompleteness; Sticky prices; Monetary policy; Welfare

A Tale of Tax Policies in Open Economies

Recent financial crises in Europe as well as the periodic battles in the U.S. over the debt ceiling point to the importance of fiscal discipline among developed countries. This paper develops an open economy model, calibrated to the U.S. and a subset of the EMU, to evaluate the impact of various permanent tax changes. The first set of experiments considers a targeted one percentage point reduction in the government deficit-to-GDP ratio through raising one of : the consumption tax, the labor income tax, or the capital income tax. In terms of welfare, the consumption tax is found to be the least costly of the tax increases. A second set of experiments looks at deficit-neutral tax changes : partially replacing the capital income tax with either a higher labor income tax or higher consumption tax ; and partially replacing the labor income tax with an increased consumption tax. Reducing reliance on capital income taxation is welfare-enhancing, although it leads to short term losses. Reducing labor income taxation improves international competitiveness and is welfare-improving.fiscal policies; open economies; public deficits; tax reforms

Ramsey Policies in a Small Open Economy with Sticky Prices and Capital

This paper analyzes jointly optimal fiscal and monetary policies in a small open economy with capital and sticky prices. We allow for trade in consumption goods under perfect international risk sharing. We consider balanced-budget fiscal policies where authorities use distortionary taxes on labor and capital together with monetary policy using the nominal interest rate. First, as long as a symmetric equilibrium is considered, the steady state in an open economy is isomorphic to that of a closed economy. second, whereas sticky prices allocations are almost indistinguishable from flexible prices allocations, the open economydimension delivers results that are qualitatively similar to those of a closed economy but with significant quantitative changes. Fluctuations in terms of trade implied by complete international financial markets affect (i) consumption through changes in the consumption price index (CPI), (ii) hours through changes in the CPI-based real wage and (iii) capital accumulation through the relative price of capital goods. These wedges affect the volatility and persistence of optimal tax rates, and resulting allocations are quite different, as compared to a closed economy.small open economy; sticky prices; optimal monetary and fiscal policies

Politique monétaire optimale et effet de variété en économie ouverte

Cet article étudie la manière dont la politique monétaire doit être conduite en économie ouverte lorsque l'on prend en compte son influence sur la marge extensive de l'activité. Dans un modèle à deux pays, on montre que, contrairement aux résultats obtenus par Bilbiie, Ghironi et Melitz [2007], la politique monétaire optimale consiste à stabiliser les prix à la consommation, la stabilisation des prix à la production induisant un a justement insuffisant du taux de change réel. D'autre part, lorsque l'on tient compte de la marge intensive de l'activité, l'adoption d'un régime de change fixe entraîne une sur–volatilité macroéconomique qui génère des coûts en termes de bien–être lorsque les relations commerciales sont importantes et que les heures travaillées sont fortement élastiques au salaire réel.politique monétaire optimale; économie ouverte; effet de variété; marge extensive