A monetary union is modelled as a technology that makes a surprise policy deviation impossible and requires voluntarily participating countries to follow the same monetary policy,Within a fully dynamic context,we show that such an arrangement may dominate a regime with independent national currencies,Two new results are delivered by the voluntary participation assumption,First,the optimal plan is shown to respond to a country's temptation to leave the union by tilting both current and future policy in its favour,This yields a non-linear rule according to which each country weight in policy decisions is time-varying and depends on its incentive to abandon the union,Second,we show that there might be conditions such that a break-up of the union,as has occurred in some historical episodes,is efficient,The paper thus provides a first formal analysis of the incentives behind the formation,sustainability,and disruption of a monetary union.
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