Monetary Policy in Currency Unions with Unequal Countries

Lukas Boehnert (), Sergio de Ferra (), Kurt Mitman () and Federica Romei ()
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Lukas Boehnert: University of Oxford
Sergio de Ferra: University of Oxford
Kurt Mitman: Stockholm University
Federica Romei: University of Oxford

No 17950, IZA Discussion Papers from Institute of Labor Economics (IZA)

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. Pro-cyclical 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: currency union; monetary policy; inequality (search for similar items in EconPapers)
Date: 2025-06
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