Ashley Wumian Zhao

Optimal Monetary Policy and the Welfare Cost of Inflation of a Currency Union

This paper studies the welfare cost of inflation and optimal monetary policy of a currency union between two countries using a search-theoretic framework with endogenous composition of buyers and sellers. The model includes three features of a currency union that are key to welfare and policy analysis: heterogeneous market structure (characterized by buyers' bargaining power), imperfect market integration, and immigration policy.

The model yields optimal monetary policy that deviates from the Friedman rule, with the magnitude of the optimal inflation rate and welfare cost of inflation determined by different policy regimes. The Friedman rule is suboptimal, because of a matching congestion externality in the labor market arising from the endogenous composition of buyers and sellers. Higher labor mobility reduces the cost of inflation by alleviating congestion, regardless of buyers' bargaining power. Market integration may also reduce congestion, lowering the cost of inflation, but only when sellers are relatively scarce.

Liquidity, Collective Moral Hazard, and Government Bailouts

The paper develops a general equilibrium model of assets market integrating a theory of liquidity risk in a New Monetarist framework. Collective moral hazard arises from the interaction between banks' maturity transformation and government intervention. With the anticipation and implmentation of government bailouts during a crisis, collective moral hazard creates current and deferred social costs. However, under the ``correct" monetary policy, the costs are justified by the improvement of liquidity condition as a result of higher provision of public and private liquidity.

On Cross-Border Payments and the Industrial Organization of Correspondent Banking

Despite advances in domestic payments arrangements, cross-border payments remain costly and slow. This paper builds a model of cross-border payments where market power in correspondent banking relationships reduces efficiency. We consider two policy experiments: the introduction by one country of an internationally held CBDC, and development of an internationally interoperable settlement system. Both policies can at least attenuate the inefficiencies in cross-border payments, but neither is automatically a complete solution nor are they without difficulties. For an international CBDC, we identify a political economy barrier: banks of the country potentially introducing the CBDC disproportionately suffer losses while benefits tend to accrue to foreign depositors, so a central bank concerned with its domestic banks' profitability may be unlikely to take such an action. Interoperability does not face the same barrier, as benefits accrue more symmetrically, but we argue that technical and other issues inherent to interoperability may be difficult to overcome.