Financial market integration and business cycle volatility in a monetary union

This paper uses a dynamic general equilibrium two-country sticky-price model to analyze the implications of financial market integration for the propagation of asymmetric productivity and government spending shocks in a monetary union. Financial market integration has a small effect on the propagation of these shocks if households can only trade in risk-free bonds. However, financial market integration has a more substantial effect on the propagation of these shocks in a monetary union with a complete market for state-contingent claims. This result indicates that it may be important to account for threshold effects in empirical analyses of the impact of financial market integration on business cycle volatility in a monetary union.