Indebtedness and Macroeconomic Imbalances in a Monetary-Union DSGE Model

The euro area crisis highlights the issue of sovereign debt in a heterogeneous monetary union. This heterogeneity concerns, in particular, inflation rates, GDP growth rates, current account balances and ratios of public deficits and debts to GDP. This paper mainly aims to investigate such macroeconomic divergences, in a DSGE model of two countries belonging to a monetary union open with the rest of the world. We first focus on divergences coming from asymmetric shocks affecting domestic production costs. Divergences are also introduced in the governments' behavior, which may conduct pro-cyclical or counter-cyclical fiscal policy, as well as in the market perception on the default risk of some member countries. An asymmetric shock on sovereign risk premia is also simulated in order to discuss the transmission of financial shocks within the union. Special attention is given to two main mechanisms: the financing of government debt from banks in a risky environment and the impact of the openness of the union toward the rest of the world