Liquidity-constrained consumers and optimal monetary policy in a currency union

Keywords Optimal monetary policy; Liquidity-constrained consumers; Currency union; Nominal wage rigidity; Two-country new Keynesian model Highlights * We examine optimal monetary policy in a currency union with liquidity-constrained (LC) consumers. * The response of macroeconomic variables to foreign shocks is dampened as a share of foreign LC consumers increases. * The costs of discretionary policy are generally not greater if LC consumers exist in both countries. * The presence of nominal wage rigidity significantly lowers welfare losses. Abstract This paper examines optimal monetary policy in a currency union model with liquidity-constrained (LC) consumers. The result demonstrates that given LC consumers in the home country, the response of macroeconomic variables to a foreign structural shock is generally dampened as a share of foreign LC consumers increases. This paper finds that the costs of discretionary policy are generally not greater in a currency union in which LC consumers exist in both countries. We address that the presence of nominal wage rigidity significantly lowers welfare losses in our model. Author Affiliation: Faculty of Economics, Momoyama Gakuin University, 1-1, Manabino, Izumi, Osaka 594-1198, Japan Research Fellow, Graduate School of Economics, Kobe University, Japan * Address: Faculty of Economics, Momoyama Gakuin University, 1-1, Manabino, Izumi, Osaka 594-1198, Japan. (footnote)[white star] I would like to thank Mark M. Spiegel and two anonymous referees for their helpful comments and suggestions. Also I would like to thank Real Arai, Yuichi Furukawa, Kohei Hasui, Ryo Hasumi, Hirokuni Iiboshi, Minoru Kunisaki, Yoichi Matubayashi, Shin-ichi Nishiyama, and Mitsuhiro Okano for their helpful comments and suggestions. This paper was supported by JSPS KAKENHI Grant Numbers JP16H03618 and JP20K01784. All remaining errors are my own. Byline: Daisuke Ida [ida-dai@andrew.ac.jp] (*)