Automatic Stabilizers in Monetary and Fiscal Unions


This paper develops a multi-country New-Keynesian model with heterogeneous agents and incomplete markets calibrated to the Euro area to assess the role of automatic stabilizers in a monetary union when countries are affected by country specific shocks. In a monetary union, monetary policy is constrained in two ways. First, it cannot condition on country specific shocks. Second, countries cannot resort to nominal devaluation of the exchange rate. Recent literature shows that automatic stabilizers are particularly important when monetary policy is constrained. Furthermore, to capture positive spillovers within the closely connected countries in the Euro area, I explicitly model trade linkages between countries. The model developed in this paper provides a framework to analyze the counterfactual implementation of elements of a fiscal union and asks: Are there benefits of a unified fiscal authority?