Monetary Union, Asymmetric Recession, and Exit

We propose a New Keynesian DSGE model of the Eurozone and analyze an asymmetric recession in a vulnerable member state characterized by a trilemma of high public debt, weak banks, and deteriorating competitiveness. We compare macroeconomic adjustment under continued membership with two exit scenarios that introduce flexible exchange rates and autonomous monetary policy. An exit with stable investor expectations could significantly dampen the short-run impact. Stabilization is achieved by a targeted monetary expansion combined with depreciation. However, investor panic may lead to escalation, aggravate the recession and delay the recovery.