Monetary Policy in Currency Unions with Unequal Countries

Lukas Boehnert, Sergio de Ferra, Kurt Mitman and Federica Romei

No 19872, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We investigate how the composition of expenditure shapes the transmission of monetary policy in a currency union. European Monetary Union data reveal three facts: (1) higher inequality countries have larger service expenditure shares; (2) monetary policy has a weaker output impact in these high-service-share, high-inequality countries; and (3) monetary policy induces systematic trade flows between high- and low-service-share countries. We develop a New Keynesian model with non-homothetic preferences and heterogeneous sectoral income that rationalizes these facts. Procyclical inequality, driven by wealthier households’ greater income exposure to services, buffers poorer households’ consumption to contractionary shocks, dampening overall policy transmission. Our findings suggest that accounting for cross-country differences in consumption and income distributions is essential for understanding common monetary policy.

Keywords: Monetary policy; Monetary union; International capital flows; Non-homothetic preferences (search for similar items in EconPapers)
JEL-codes: E21 E52 F36 (search for similar items in EconPapers)
Date: 2025-01
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