Research

In Monetary Unions, fiscal adjustment pace critically determines Central banks’ stabilization capacity. Standard macroeconomic theory suggests that with Ricardian households, fiscal adjustment should be rapid enough to support monetary dominance. However, with Non-Ricardian households the monetary authority may prefer fiscal adjustment to be slow. I extend this debate to Monetary Unions, where cross-border spillovers complicate fiscal-monetary coordination. I employ a two-country Monetary Union with positively correlated shocks. The results show that: (1) when demand shocks dominate, slow adjustment is optimal under both uniform and heterogeneous fiscal frameworks; (2) when supply shocks dominate, in the uniform framework, the optimal fiscal adjustment depends on the the degree of shock correlation and the Central bank weight towards the least affected economy, while in hetero- geneous frameworks the answer depends only on the former; (3) heterogeneous frameworks outperform their uniform counterparts. Importantly, these results extend to N > 2 country Monetary Unions.