Monetary regimes in open economies

This thesis presents a two-country open economy framework for the analysis of strategic interactions among monetary authorities and wage bargaining institutions. From this perspective, the thesis investigates the economic consequences of replacing flexible and fixed exchange rate regimes with a monetary union, such as the European Economic and Monetary Union. It shows that fixing a currency creates a flatter Phillips curve and increases the aggressiveness of wage demands by labor unions. Compared to the existing literature, this open economy approach shows diametrically opposite results from replacing a regime of fixed exchange rates with a monetary union. This framework also shows that the high conservativeness of a central bank is beneficial for a foreign economy. Furthermore, the thesis studies the effects of shocks across countries and shows that optimal monetary policy reverses the direct effect of a productivity shock on foreign output. Hence, it reveals a mechanism that can explain the output anomaly identified by Backus, Kehoe and Kydland, that productivity shocks generate positively correlated output across countries. Understanding these mechanisms allows policymakers to consider the strategic implications of the design of institutions and policy in an open economy.