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SUMMARY:UCLouvain Seminar : Luca Fornaro
DTSTART:20191010
DTEND:20191010
DESCRIPTION:Monetary Union and Financial Integration

Luca Fornaro\, CREI

Abstract: It is often argued that forming a monetary union increases financial integration and leads to a more efficient allocation of capital across member countries. To investigate this claim\, this paper provides a model connecting monetary policy and international capital flows. The key feature of the model is that &nbsp\;monetary policy affects the value of collateral that can be repossessed by creditors in case of default.&nbsp\; Once a country has accumulated a large stock of &nbsp\;external debt\, &nbsp\;it is optimal for the government &nbsp\;to depreciate the exchange rate to expropriate foreign investors.&nbsp\; Anticipating this\, under flexible exchange rates international investors &nbsp\;impose tight borrowing limits on foreign debtors.&nbsp\; In a monetary union this source of exchange rate risk is absent\, because national governments do not control monetary policy. Forming a monetary union thus increases financial integration by boosting borrowing capacity toward foreign investors. This process\, however\, does not necessarily lead to higher welfare. Higher financial integration may increase welfare by fostering capital flows from capital-abundant to capital-scarce countries. But a high degree of financial integration may also make episodes of inefficient capital flights out of capital-scarce countries possible.

LOCATION:Doyen 22\, \, Louvain-la-Neuve 1348\,  BE
DTSTAMP:20241222
UID:6768688623c55
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