Welfare Implications of Country Size in a Monetary Union

Abstract

This paper calculates di¤erences in welfare costs of nominal rigidities in large and small EMU countries. I use a two-country DSGE model characterized by optimizing agents, monopolistic wage and price setting, distortionary taxes and government debt dynamics. I …nd that these costs are virtually identical for all members of the EMU, and small countries are not at a disadvantage when it comes to the setting of the common monetary policy. This conclusion is primarily due to highly correlated technological processes in Europe, which cause national and Euro-wide in ‡ations to move together. These …ndings are robust to the asset market structure, trade openness, and di¤erent speci…cations of the Taylor rule.