In monetary unions, monetary policy is typically made by delegates of the member countries. This procedure raises the possibility of strategic delegation- that countries may choose the types of delegates to influence outcomes in their favor. We show that without commitment in monetary policy, strategic delegation arises if and only if three conditions are met: shocks affecting individual countries are not perfectly correlated, risk-sharing across countries is imperfect, and the Phillips Curve is nonlinear. Moreover, inflation rates are inefficiently high. We argue that ways of solving the commitment problem, including the emphasis on price stability in the agreements constituting the European Union are especially valuable when strategic delegation is a problem.
Published as: Monetary policy and exchange rate volatility in a small open economy in Review of Economic Studies , Vol. 72, No. 3, 707-734, July, 2005