Financial Heterogeneity and Monetary Union

Abstract

We analyze the economic consequences of forming a monetary union among countries with varying degrees of financial distortions, which interact with the firms' pricing decisions because of customer-market considerations. In response to a financial shock, firms in financially weak countries (the periphery) maintain cashflows by raising markups-in both domestic and export markets-while firms in financially strong countries (the core) reduce markups, undercutting their financially constrained competitors to gain market share. When the two regions are experiencing different shocks, common monetary policy results in a substantially higher macroeconomic volatility in the periphery, compared with a flexible exchange rate regime; this translates into a welfare loss for the union as a whole, with the loss borne entirely by the periphery. By helping firms from the core internalize the pecuniary externality engendered by the interaction of financial frictions and customer markets, a unilateral fiscal devaluation by the periphery can improve the union's overall welfare.

Monetary Policy and Local Industry Structure

“…The difference between the policy rate set by the European Central Bank (ECB) and the "optimal" rate implied by a country-specific Taylor rule then constitutes an exogenous measure of the monetary policy stance, from the point of view of the individual country. This is broadly consistent with how the literature has estimated "optimal" country-specific or region-specific monetary policy objects, such as Taylor rules and Phillips curves (e.g., Nechio (2011), Drometer et al (2018), Gilchrist et al (2018), and Ilzetzki et al (2020)).…”

Variation in the Phillips Curve Relation Across Three Phases of the Business Cycle

“…Fernández et al (2015) demonstrate that, in Spain, average markups rose in half of the sectors after 2008. Gilchrist et al (2017) develop a New Keynesian model, extended in Gilchrist et al (2018), that builds upon these insights, and provide supportive empirical evidence. These authors draw attention to the standard IO theory, but further note a nuance to this basic relationship.…”

“…In the model of Gilchrist et al (2017), financial frictions imply that markups remain elevated after the initial adverse demand (or financial) shock. 24 Evidence in both Gilchrist et al (2017) and Gilchrist et al (2018) is supportive; for instance, financially constrained firms in the US, on average, raised prices at the onset of the Great Recession, while other firms dropped prices aggressively and increased their market share. 25 Prices remained flat for about a year, then began to rise again.…”

“…also draws attention to the notion of market share as an investment good, with the concomitant influence of the interest rate on prices. For a model featuring countercyclical markups driven by exit, in the absence of financial frictions, seeCheremukhin and Tutino (2016).25 Asplund, Ericksson, and Strand (2005), Lundin et al (2009), and Montero and Urtasun (2014) find similar evidence Gilchrist et al (2018). find a similar dichotomy between firms in financially weak versus financially strong countries in Europe.…”

Simulation of Systemic Risk as a Consequence of Fire Sales: Application to EU Banking Sector

“…I když se v literatuře objevují názory kritizující tradiční přístup (Blanchard, 2016;Krugman, 2011nebo Fagiolo a Roventini, 2016, z metodologického hlediska je nejlépe chápat oba přístupy jako komplementární metody. Tuto tendenci lze vysledovat v postupném zahrnutí heterogenity agentů v modelech všeobecné rovnováhy (viz Kaplan et al, 2018) pro HANK model inkorporující heterogenní charakteristiky domácností, nebo Gilchrist et al (2018) pro DSGE modely s heterogenními podniky.…”