Monetary union with sticky prices and direct spillover channels

This paper derives a sticky-price, forward-looking model of a monetary union (MU) of two countries, with trade across countries and immobile labour. Contrasting to the existing literature, the resulting laws-of-motion do not resort to spillovers via aggregate, union-wide magnitudes but instead feature direct impact of the output gap of the respective other country, and indirect impact of price dynamics via the the consumer price indices (CPIs). Further, the paper analyses the equilibrium dynamics of a variant of the model under various exogenous shocks, most prominently, idiosyncratic shocks to cover diverging developments of the different regions of an MU. A numerical analysis of the parameter calibration for saddlepath-stable behaviour is provided. I find i.a. that idiosyncratic shocks result in heavily oscillating behaviour due to unsynchronised spillovers and reactions of the central bank.