Welfare Implications of the Design of a Currency Union in Case of Member Countries of Different Sizes

Abstract

In the study, the relevance of several optimum-currency-area (OCA) criteria is formally worked out in a welfare approach. The optimum monetary-policy rules of the supranational central bank are derived by employing the Barro-Gordon framework, and consideration is given to how the welfare of the member countries of a currency union is affected by symmetric and asymmetric national output shocks. The central-bank council may consist of a central-bank board and of a group of national central-bank presidents, where the national presidents are assumed to focus on their home economies. In a two-country framework, the countries are allowed to differ in size, and different degrees of labour mobility are addressed. The welfare implications are both deduced analytically and with the use of simulations. It is shown that relatively small member countries favour a situation where the group of national central bank presidents is in a strong position while large countries prefer decisions to be taken by the central-bank board. The preferences are the stronger the lower the degree of labour mobility. Besides, differences in the national monetary transmission processes as well as divergent national inflation and output preferences affect welfare. (JEL E52, E58, E61)