Macroeconomic Analysis of Monetary Unions

Recent years have seen an increasing interest in the concept of monetary union, i.e., the adoption of a common currency by a group of countries. However, there have been no parallel attempts at a general theoretical analysis of monetary unions. In this Brief, we provide a general framework for the macroeconomic modelling of monetary unions, by adapting an otherwise standard model within the Mundell–Fleming tradition, which represents the reference model in most textbooks on international macroeconomics. The starting point of the analysis is the standard two-country Mundell–Fleming model with perfect capital mobility, extended to incorporate the supply side in a context of rigid real wages, and modified so that the money market becomes a common one for two countries forming a monetary union. Two versions of the model are presented: one for a small and one for a large monetary union. After solving each model, we derive multipliers for monetary, expenditure, supply, and external shocks, both in the short and the long run. Special attention is paid to the crucial distinction between symmetric and asymmetric shocks.