Bonded Together? Welfare and Stability in a Monetary Union with Core–Periphery Preference Convergence

We study the macroeconomic and welfare consequences of bond preference convergence within a monetary union. Using a two-country DSGE model calibrated to Germany and Spain, we compare two scenarios: convergence toward Spanish bond preferences and convergence toward German bond preferences. The direction of convergence proves decisive. When preferences shift toward those of Spain, union-wide private debt expands, long-run GDP declines, and macro-financial volatility rises, though inflation volatility falls. Welfare increases for the union as a whole in this scenario, with Germany gaining the most and Spain benefiting more modestly. By contrast, convergence toward German bond preferences reduces union-wide private debt and output volatility, but generates only moderate welfare gains for Germany and significant welfare losses for Spain. These results highlight that financial convergence does not yield uniform benefits. Its consequences depend on both the direction of convergence and its distributional effects across countries and households. The findings also point to a trade-off between welfare and stability, underscoring the need for macroprudential tools and fiscal arrangements to manage the risks associated with deeper convergence in bond preferences.