We study the optimal monetary policy in a two-country open-economy model under two monetary arrangements: (a) multiple currencies controlled by independent policy makers; (b) common currencies with a centralized policy maker.

Our findings suggest that: (i) Monetary policy competition leads to higher long-term inflation and interest rates with large welfare losses; (ii) The inflation bias and the consequent losses are larger when countries are unable to commit to future policies; (iii) the welfare losses from higher long-term inflation dominates the welfare costs of losing the ability to react optimally to shocks. Therefore, the coordination of policies implicit in the adoption of a common currency has positive welfare consequences.