Monetary Politics in a Monetary Union: A Note on Common Agency with Rational Expectations

Is the politicisation of monetary policy in a currency union desirable? This paper shows that in a setting where political influence by national governments is modeled as a common agency game with rational expectations, the answer to this question crucially depends on whether the common central bank can commit to follow its policy.Common Agency, Political Pressures, European Monetary Union

Rent Seeking, Market Structure and Growth

We construct a model where firms compete in both political and economic markets. In political markets, firms compete for influence over government transfer policy (rents). This activity can be beneficial for the firm, but is purely wasteful from the point of view of society because resources are utilized to achieve a redistribution of income. In the economic market, firms compete for market share through cost reducing technological innovation. Market structure plays an important role in this economy because competition drives firms to invest more in innovation resulting in higher growth. Rent-seeking affects economic growth in two important ways. It diverts resources away from innovation and it affects the number of firms that are supported in equilibrium. The former has a negative effect on growth while the latter effect is ambiguous, depending on whether rent seeking induces entry or exit. This market structure effect depends on a combination of political and economic factors that the theory highlights.Rent Seeking, Market Structure, R&D Investment, Growth, Welfare

The Immigration Policy Puzzle

This paper revisits the puzzle of immigration policy: standard economic theory predicts that free immigration improves natives' welfare, but (with few historical exceptions) an open door policy is never implemented in practice. What rationalizes the puzzle? We first review the model of immigration policy where the policy maker maximizes national income of natives net of the tax burden of immigration (Borjas, 1995). We show that this model fails to provide realistic policy outcomes when the receiving region's technology is described by a standard Cobb-Douglas or CES function, as the optimal policy imposes a complete ban on immigration or implies an unrealistically large number of immigrants relative to natives. Then the paper describes three extensions of this basic model that reconcile the theory with the evidence. The first introduces a cost of integration of the immigrant community in the destination country; the second takes into account the policy maker's redistributive concern across different social groups; the last extension considers positive spillover effects of (skilled) migrants on the receiving economy.Costs and benefits from immigration; immigration policy.

The role of economic theory in WTO arbitrations

How can economic theory be useful in WTO arbitrations? Motivated by this question, this paper reviews the approach that is often used to determine the level of permissible retaliation in international trade disputes (the, so called, "trade effect" approach), and its implementation under specific policy scenarios (tariffs, quotas, subsidies). Through these examples, the paper argues that economic theory, in addition to quantitative economics, can play a useful role in assisting WTO arbitrators in understanding the pros and cons of the trade effect approach and in implementing this approach under different policy scenarios

Political pressures and exchange rate stability in emerging market economies

This paper presents a political economy model of exchange rate policy. The theory is based on a common agency approach with rational expectations. Financial and exporter lobbies exert political pressures to influence the government’s choice of exchange rate policy, before shocks to the economy are realized. The model shows that political pressures affect exchange rate policy and create an over-commitment to exchange rate stability. This helps to rationalize the empirical evidence on fear of large currency swings that characterizes exchange rate policy of many emerging market economies. Moreover, the model suggests that the effects of political pressures on the exchange rate are lower if the quality of institutions is higher. Empirical evidence for a large sample of emerging market economies is consistent with these findings.exporters and financial lobbies, exchange rate stability

The relationship between exchange rates and international trade: A literature review

This paper surveys a wide body of economic literature on the relationship between currencies and trade. Specifically, two main issues are investigated: the impact on international trade of exchange rate volatility and of currency misalignments. On average, exchange rate volatility has a negative (even if not large) impact on trade flows. The extent of this effect depends on a number of factors, including the existence of hedging instruments, the structure of production (e.g. the prevalence of small firms), and the degree of economic integration across countries. The second issue involves exchange rate misalignments, which are predicted to have short-run effects in models with price rigidities. However, the exact impact depends on a number of features, such as the pricing strategy of firms engaging in international trade and the importance of global production networks. This effect is predicted to disappear in the long-run, unless some other distortion characterizes the economy. Empirical results confirm that short-run effects can exist, but their size and persistence over time are not consistent across different studies

Why Immigration Policy Should Be a Federal Policy: Considerations on the EU and the US

In a union of states such as the EU or the US, should immigration policy be decentralized or should it be a federal policy? Experience and economic logic offer a simple argument against decentralization. Because immigration reforms in one state are felt beyond its borders, other states will respond in kind. Decentralization will, therefore, create coordination problems between states and will reduce their individual and collective ability to manage immigration. In the EU and the US, the existence of a federal policy is a precondition for an effective management of migratory flow