Stabilization of supply shocks in a structurally heterogeneous monetary union✰

The paper provides accurate theoretical results regarding the consequences of heterogeneities between the preferences or between the structural parameters of the member countries of a monetary union on monetary and fiscal policies, and on the stabilization of economic activity and inflation, in case of supply shocks. Economic activity and inflation are higher (smaller) in a country affected by a positive (negative) symmetric or asymmetric supply shock, despite the more contractionary (expansionary) fiscal policy in this country. In this context, we find that monetary unification could be more painful for a country with a small preference for stabilizing the budget deficit or economic activity, and on the contrary with a high preference for stabilizing inflation. Besides, regarding structural heterogeneities, monetary unification could be more painful for a country with strong transmission mechanisms of monetary policy or with a small budget multiplier. Membership in a monetary union could also be more painful for a country with a high (if the shock is symmetric) or small (if the shock is asymmetric) sensitivity of national prices to foreign prices. Regarding symmetric supply shocks, it could also be more painful for a country with a high sensitivity of national prices to national economic activity, or with a small sensitivity of its demand to foreign activity.