Monetary-Fiscal Wage Interactions in a Multi-Country Currency Union

This paper studies a multi-country currency union of small open economies. Demand-side disturbances hamper monetary union stabilisation unless participating countries’ business cycles are perfectly synchronised. In the face of country-specific supply shocks, a currency union of small open economies underperforms monetary autonomy. Higher preference for price stability also deteriorates monetary union stabilisation performance. Monetary-fiscal interaction leads to a free rider problem, with supply shocks eliciting higher interest rate variability. Wage bargaining attempting at stabilising real wages and output mitigates the free rider problem. Decentralised wage bargaining and a lower wage sensitivity of output favour a currency union over monetary autonomy.