The Monetary Consequences of a Free Trade Area of the Americas

How will free trade affect monetary policy and exchange rate regime choices in the Americas? While the European Union illustrates how the creation of an integrated market in goods and services can enhance monetary cooperation and integration, it is not clear that Europe's experience translates to Latin America, where the political circumstances are different. We try to understand whether the monetary consequences of existing regional trade agreements, including but not limited to the European Union, mainly reflect spillovers from trade integration, or whether observed outcomes have been mainly about politics. Our results incline us toward the latter interpretation, leaving us pessimistic about the basis for deeper monetary cooperation. If exchange rate volatility is to be tamed, then the more widespread adoption of inflation targeting, which we find to be associated with a significant reduction in bilateral exchange rate volatility, may be the most promising path.