Fiscal Stabilisation in the EMU

This paper analyses the effects of macroeconomic shocks in a monetary union with the aid of a two-country model of the EMU. Our analysis serves two purposes. First, we show how asymmetries between countries might matter in terms of the resulting business cycle fluctuations. More specifically, we do not only allow for country-specific shocks but also for cross-national differences in wage behaviour. Secondly, we show by means of numerical simulations how fiscal policy can be used to dampen business cycle fluctuations in various (a)symmetric settings. We consider two types of fiscal policy, national fiscal stabilisation and stabilisation from a federal system of fiscal transfers between countries, and we derive their welfare implications. The main innovation of the paper is to illustrate how structural differences between countries, e.g. a varying degree of wage rigidity, help to determine the impact of macroeconomic shocks and the effectiveness of fiscal policy. So far, this kind of asymmetry has been given little attention in the literature on fiscal policy in the EMU.