Time Inconsistency and Free‐Riding in a Monetary Union |
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| Authors: | VARADARAJAN V. CHARI PATRICK J. KEHOE |
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| Affiliation: | 1. Varadarajan V. Chari is the Paul W. Frenzel Land Grant Professor of Liberal Arts, Department of Economics, University of Minnesota, 4‐101 Hanson Hall, 1925 Fourth Street South, Minneapolis, MN 55455, and a Consultant, Research Department, Federal Reserve Bank of Minneapolis, 90 Hennepin Avenue, Minneapolis, MN 55401‐1804 (E‐mail: chari@res.mpls.frb.fed.us).;2. Patrick J. Kehoe is the Frenzel Professor of International Economics, Department of Economics, University of Minnesota, 4‐101 Hanson Hall, 1925 Fourth Street South, Minneapolis, MN 55455, and a Monetary Advisor, Research Department, Federal Reserve Bank of Minneapolis, and Research Associate, National Bureau of Economic Research, 1050 Massachusetts Avenue, Cambridge, MA 02138‐5398 (E‐mail: pkehoe@res.mpls.frb.fed.us). |
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| Abstract: | In monetary unions, a time inconsistency problem in monetary policy leads to a novel type of free‐rider problem in the setting of non‐monetary policies. The free‐rider problem leads union members to pursue lax non‐monetary policies that induce the monetary authority to generate high inflation. Free‐riding can be mitigated by imposing constraints on non‐monetary policies. Without a time inconsistency problem, the union has no free‐rider problem; then constraints on non‐monetary policies are unnecessary and possibly harmful. This theory is here detailed and applied to several non‐monetary policies: labor market policy, fiscal policy, and bank regulation. |
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| Keywords: | E42 E58 E61 E63 F3 F33 F41 F42 monetary regime fixed exchange rates dollarization European Union Maastricht Treaty |
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