Fiscal Stabilization in the EMU

This paper analyzes the effects of macroeconomic shocks in the Economic and Monetary Union (EMU) using a stylized two‐country model. First, it is shown how asymmetries between countries might matter in terms of the resulting business cycle fluctuations. More specifically, country‐specific shocks are allowed for as well as cross‐national differences in wage behavior. Second, it is shown by means of numerical simulations how national and federal fiscal stabilization policies can be used to dampen business cycle fluctuations in various (a)symmetric settings. The main innovation of the paper is to illustrate how structural differences between countries help to determine the impact of macroeconomic shocks and the effectiveness of fiscal policy.