1 Introduction

Mundell (1963) Fleming (1962)

In the classical trade-off by Mundell (1961), the costs of a monetary union are only arising from not sharing the same exchange rate, which shuts down the boost to exports done by a depreciation when there is a crisis. Moreover, a counry in a currency union cannot use its monetary policy to smooth out shocks. This paper shows that in a fixed exchange rate regime, macroeconomic fundamentals (consumption?) are more volatile because capital inflows do not fear the risk of a devaluation. Therefore, for a given fiscal shock – for example – there is a much bigger response in a currency union, and the stimulative aggregate demand effects are much more spread than if not. Note indeed that in the case of government debt, the principal is also important: the full sequence of all interest rates, and the full sequence of all exchange rates, matters, in order to determine the value of the debt.

2 Model

Consumers get a fiscal boost. The question is how much this stimulates local production or foreign production. There are two sides to the transaction:

1. who finances the bond buying. If it’s local production that’s stimulated, then the extra saving can perfectly finance the bond buying
2. if not, then it’s the foreign country that is now saving more and they can buy my government bonds as a store of value.

If consumers want to buy foreeign goods, then there are two possibilities: either they buy foreign currency, with domestic currency, which drives up the price of the foreign currency?

3 Exchange-rate Stabilization programs

Rebelo and Vegh (1995)

4 Countries which peg to the dollar

Problems indeed: capital flows. It’s good for trade, because it creates more security for exporters. Howeveer it makes you very sensitive to capital flows. Thus, conditional on exchange rate shocks, it’s bad.

A risk of exchange rate depreciation is like a tarriff?

A Figures

A.1 Euro Area Interest Rate Convergence

Figure A.1: Long-Term Interest Rates

Figure A.2: Long-Term Interest Rates (1990-2019)

Figure A.3: Long-Term Interest Rates in PIIGS and Germany (1990-2019)

A.2 Unit Labor Cost

Figure A.4: Unit Labor Costs (1990-2000)

Figure A.5: Unit Labor Costs (2000-2019)

B Exchange-Rate Based Stabilization: Crises

Figure B.1: Crises episodes: Relative price of nontradable goods, trade balance, and current account (from Vegh (2013))

B.1 Argentina 1982

Figure B.2: Argentina Exchange Rate (around 1982)

Figure B.3: Argentina Current Account (around 1982)

B.2 Chile 1982

Figure B.4: Chile Exchange-Rate (around 1982)

Figure B.5: Chile Current Account (around 1982)

B.3 Uruguay 1982

Figure B.6: uruguay Exchange-Rate (around 1982)

B.4 Mexico 1994

Figure B.7: Mexico Exchange-Rate (around 1994)

Figure B.8: Mexico Current Account (around 1994)

B.5 Indonesia 1997

Figure B.9: Indonesia Exchange-Rate (around 1997)

Figure B.10: Indonesia Current Account (around 1997)

B.6 Korea 1997

Figure B.11: Korea Exchange-Rate (around 1997)

Figure B.12: Korea Current Account (around 1997)

B.7 Malaysia 1997

Figure B.13: Malaysia Exchange-Rate (around 1997)

Figure B.14: Malaysia Current Account (around 1997)

B.8 Thailand 1997

Figure B.15: Thailand Exchange-Rate (around 1997)

Figure B.16: Thailand Current Account (around 1997)

B.9 Turkey 2001

Figure B.17: Turkey (2001)

Figure B.18: Turkey (2001)

B.10 Argentina 2001

Figure B.19: Argentina (2001)

Figure B.20: Argentina (2001)

C Aggregate Phillips Curves