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Monetary Policy in Currency Unions with Unequal Countries

Author

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  • Boehnert, Lukas

    (University of Oxford)

  • de Ferra, Sergio

    (University of Oxford)

  • Mitman, Kurt

    (Stockholm University)

  • Romei, Federica

    (University of Oxford)

Abstract

We investigate how the composition of expenditure shapes the transmission of monetary policy in a currency union. European Monetary Union data reveal three facts: (1) higher inequality countries have larger service expenditure shares; (2) monetary policy has a weaker output impact in these high-service-share, high-inequality countries; and (3) monetary policy induces systematic trade flows between high- and low-service-share countries. We develop a New Keynesian model with non-homothetic preferences and heterogeneous sectoral income that rationalizes these facts. Pro-cyclical inequality, driven by wealthier households' greater income exposure to services, buffers poorer households' consumption to contractionary shocks, dampening overall policy transmission. Our findings suggest that accounting for cross-country differences in consumption and income distributions is essential for understanding common monetary policy.

Suggested Citation

  • Boehnert, Lukas & de Ferra, Sergio & Mitman, Kurt & Romei, Federica, 2025. "Monetary Policy in Currency Unions with Unequal Countries," IZA Discussion Papers 17950, Institute of Labor Economics (IZA).
    • Handle: RePEc:iza:izadps:dp17950
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