Discussion paper

DP2615 Monetary Union and Fiscal Federalism

Does a monetary union need fiscal shock absorbers helping the participating countries to cope with
asymmetric shocks? The consensus in the debate over EMU argues that the answer is yes. In this paper,
we revisit the issue, building on a dynamic, general equilibrium framework of regions in a monetary union
exposed to asymmetric shocks. We show that inter-regional taxes and transfers can stabilize regional
employment or consumption, but not both. The welfare effects of such a stabilization are, however,
ambiguous. In contrast to a popular argument in the EMU debate, inter-regional taxes and transfers do not
reduce the incentives for goods and labour market deregulation in the regions, provided that the degree of
trade integration among the regions is large. There is, however, reason to coordinate regional reform policies
to avoid adverse effects on the aggregate performance of the union.

£6.00
Citation

Kletzer, K and J von Hagen (2000), ‘DP2615 Monetary Union and Fiscal Federalism‘, CEPR Discussion Paper No. 2615. CEPR Press, Paris & London. https://cepr.org/publications/dp2615