MONETARY-POLICY AND COUNTRY SIZE

This paper uses a two-country Lucas tree model with a cash in advance constraint to investigate the impact of country size on monetary policy in the presence of externalities. In this example, the externality is the holding of domestic currency by foreign firms. It is shown that large countries have a relatively smaller incentive to inflate than small countries. Cross-country empirical tests show that among industrialized countries, there exists a negative and significant relationship between the average of inflation rates between 1979 and 1989, and the average of both GDP and population. (JEL E5, F4).