The Effects of Corruption in a Monetary Union

Abstract

Many countries around the world suffer from corruption. In a monetary union, corruption varies from one country to another. It is possible corruption in one country may affect another country in a monetary union. We demonstrate that this feature has important implications in a monetary union with two asymmetric countries. Country 1 has a corrupted government while country 2 does not. Within this framework, we determine under which conditions corruption damages or benefits both countries. We find that corruption in country 1 may have a positive or negative effect on country 2. In particular, when the government of country 1 is much more concerned about public spending than output, corruption damages both countries. In addition, we investigate how country 1 could compensate country 2 for the negative externality. JEL classification: D60, D73, E52, E58, E62. Keywords: Corruption; Fiscal Policy; Monetary Policy; Monetary Union.