Abstract
The real option implicit in a country's decision of whether to leave an existing monetary union when there is uncertainty over the future benefits of this move is examined. The theoretical model used is calibrated for the current Euro-12 area by proxying policymakers’ inflation preferences with unemployment rates and debt-to-GDP ratios. A robust group of countries is observed that would choose to remain within EMU consisting of Belgium, Finland, Greece and Italy; France and Spain loosely also belong to this core. Only Luxembourg would robustly want to leave EMU; Ireland and The Netherlands, however, complement that core closely.
Notes
See e.g. Barro and Gordon (Citation1983a, Citation1983b).
See e.g. Dixit and Pindyck (Citation1994).
This adapts the setup in Barro and Gordon (Citation1983a); similar frameworks are used in Strobel (Citation2001, Citation2002, Citation2005).
There is no consensus over whether inflation follows a nonstationary or a stationary process, see e.g. Culver and Papell (Citation1997), Lai (Citation1997); a geometric Brownian motion is used for analytical ease.
The time subscripts are dropped for ease of notation.
See e.g. Barro and Gordon (Citation1983b) and Barro (Citation1983), respectively.
Given the infinite horizon framework, these approximate the application of a (real) discount rate r of 2.5% over those finite time horizons T, using
This adopts the solution strategy in Dixit and Pindyck (Citation1994, p. 210).
The geometric Brownian motion Γ has an absorbing barrier at zero.