Financial Heterogeneity in a Monetary Union

This paper addresses the issue of macroeconomic policies in a financially heterogeneous monetary union. Optimized policy rules are used, under various budgetary policy scenarios, in a two-country DSGE model. The results indicate that a Euro-wide monetary policy strategy based on national information does not offset the costs associated with the abandonment of national monetary policy. Decentralized budgetary policies need to be more proactive in countries which are structurally more sensitive to shocks. For independent common monetary policy, cooperation between governments is comparable to a coalition, causing losses for every member. Welfare improvement at the union level only results from reducing public expenditure divergences.