We provide a theory of financial fragmentation in monetary unions. Our key insight is that currency unions may experience endogenous breakings of symmetry: that is episodes in which identical countries react differently when exposed to the same shock. During these events part of the union suffers a capital flight, while the rest acts as a safe haven and receives capital inflows. The central bank then faces a difficult trade-off between containing unemployment in capital-flight countries, and inflationary ...
We provide a theory of financial fragmentation in monetary unions. Our key insight is that currency unions may experience endogenous breakings of symmetry: that is episodes in which identical countries react differently when exposed to the same shock. During these events part of the union suffers a capital flight, while the rest acts as a safe haven and receives capital inflows. The central bank then faces a difficult trade-off between containing unemployment in capital-flight countries, and inflationary pressures in safe-haven ones. By counteracting private capital flows with public ones, anti-fragmentation monetary programs mitigate the impact of financial fragmentation on employment and inflation, thus helping the central bank to fulfill its price stability mandate.
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