Optimal fiscal transfers in a monetary union

We derive the optimal fiscal transfer scheme for countries in a monetary union to offset the welfare losses resulting from asymmetric shocks and nominal rigidities. Optimal transfers involve a tradeoff between reducing national output gaps and the provision of consumption insurance across countries, where the weight of the former increases relative to the latter as consumption home bias rises. The welfare gains from optimal transfers increase in wage rigidity and trade elasticities and are particularly large when risk-sharing through financial markets breaks down. For the average euro area economy, the welfare gains from optimal transfers range from 0.50% of permanent consumption under complete markets and low wage rigidity to 6.09% of permanent consumption under financial autarky and high wage rigidity.