Internal imbalances in the monetary union with asymmetric openness

Abstract

This paper develops a two-country, two-sector model under both monetary union and flexible exchange rate regimes featured with trade openness differentials, and then uses it to examine the relative macroeconomic effects of trade openness under both regimes. Some main results emerge from our analysis regarding an adverse shock of either country-wide productivity or country-wide government expenditure. First, the decline in output is greater for a country with low openness under both regimes. Second, the monetary union will result in a greater decline in output if the monetary authority attaches a higher weight to output stabilization. Third, the high elasticity of substitution results in a greater difference in output between the two regimes.