The Dynamic Effects of Country Specific Shocks in a Monetary Union

Abstract

This paper uses a dynamic stochastic general equilibrium model with three countries to study the effects of implementation of an open monetary union on international fluctuations. We consider the effects of unanticipated country specific shocks on technology and government spending. We compare the resulting fluctuations to a benchmark case with three independent currencies. We find that the implementation of monetary union reverses the expenditure switching effects between the goods produced inside the monetary union and that the implementation of monetary union stabilizes the fluctuations caused by shocks emerging inside the monetary union. We also find that countries benefit more from positive technology shocks when they are members of a monetary union and that in the monetary union the negative spillovers resulting from fiscal expansion by one member country are rather small.

Keywords: Monetary union, government spending, terms of trade

JEL Classification: F33, F41