More than average – designing monetary policy in a currency union with downward nominal wage rigidity

Michal Kobielarz () and Christian Probsting ()
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Michal Kobielarz: KULeuven
Christian Probsting: KULeuven

No 499, Working Paper Research from National Bank of Belgium

Abstract: Standard monetary policy in currency unions targets aggregate averages, ignoring crosssectional business cycle dispersion. Incorporating downward nominal wage rigidity into a multi-country New Keynesian framework, we analyze optimal monetary policy when asymmetric shocks generate regional labor market slack. Optimal policy pursues a capped “grease-the-wheels” strategy, balancing the benefits of eroding rigid real wages against price dispersion costs. Crucially, for a given level of aggregate unemployment, optimal policy is strictly less inflationary under cross-sectional shocks than under aggregate shocks. This occurs because inflating the union imposes costly price dispersion across all member states while easing slack in only a subset, and because terms-of-trade leakage further diminishes inflation’s effectiveness in constrained regions. Consequently, optimal monetary policy must look beyond union-wide averages and condition its stance on the share of constrained member states.

Keywords: Optimal monetary policy; Currency unions; Downward nominal wage rigidity; Asymmetric shocks; Grease-the-wheels (search for similar items in EconPapers)
JEL-codes: E24 E52 F41 F45 (search for similar items in EconPapers)
Pages: 44 pages
Date: 2026-10
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Persistent link: https://EconPapers.repec.org/RePEc:nbb:reswpp:202610-499

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