"Asymmetric information and monetary policy in common currency areas

In a Common Currency Area the Common Central Bank sets a uniform rate of inflation across countries, taking into account the area’s economic conditions. Suppose countries in recession favor a more expansionary policy than countries in expansion: when national business cycles are not fully synchronized a conflict of interest between members arises. If member governments have an informational advantage over the state of their domestic economy, such conflict may create an adverse selection problem: national authorities overemphasize their shocks, in order to shape the common policy towards their needs. This creates an inefficiency over and above the one-policy-fits-all cost discussed in the optimal currency area literature. In order to minimize this extra-burden of asymmetric information, monetary policy must over-react to large symmetric shocks and under-react to asymmetric shocks of different size.