This research seeks to give an answer to the question of what are the effects of monetary policy measures in a currency union, in an environment where fiscal policy is nation-specific. Put differently, how the absence of a fiscal union affects the propagation of monetary policy shocks. These effects are studied in two dimensions: the first dimension identifies the impact of monetary policy on a union level, i.e. when all national economies are aggregated; the second dimension studies the effect on a cross-country level. National economies differ with respect to tax regimes; I assume different degree of labor income tax progressivity, resembling the case of the Euro Area. Tax progressivity redistributes income within the country cross-sectionally, from rich to poor households, which is the main rationale for its introduction. Does and to what extent tax progressivity improve welfare of a country and how does interaction with other tax regimes affect a welfare on a union level subject to a common monetary policy is the main issue I intend to focus on. My prior is that heterogeneity among countries and financial frictions to which members of a union are exposed to, imply a strong insurance role tax redistribution provides to credit constrained agents. Moreover, failure of international risk-sharing means that some countries might experience indeterminacy, even when there is determinacy on a union-level.
This research belongs to a new strand of literature developing a new generation of macroeconomic models. The main motive for its emergence is the financial crisis that uncovered large shortcomings of the prevalent modelling approach at the time. The new approach takes micro-foundations more seriously and focuses more on capturing results from empirical data. The result is a move from representative agent framework toward more realistic heterogeneous framework, the one where agents differ in their wealth holdings, income and constraints they face, hence also in ability to successfully smooth their consumption profiles. Therefore, we move from the premise of Arrow-Debreu complete markets with contingent bonds to a more realistic environment where agents might not be able to insure themselves against all sorts of risks they might be subject to. The main contribution of my research is that it discusses for the first time the implications of the lack of fiscal union for the propagation of monetary policy shocks when markets are incomplete. As stated above, it marries literature on monetary policy in a currency union, the role of fiscal stabilizers in taming the business cycles and incomplete market literature. Outcomes on both national and union-level are compared with the case of complete markets and unique fiscal policy, which will allow me to estimate the gains from fiscal integration Euro Area. My research allows for various extensions and experiments which I intend to explore in depth.