Financial Heterogeneity and Monetary Union

58 Pages Posted: 29 Jun 2018 Last revised: 21 Feb 2019

See all articles by Simon Gilchrist

Simon Gilchrist

New York University (NYU)

Raphael Schoenle

Brandeis University

Jae Sim

Board of Governors of the Federal Reserve System

Egon Zakrajsek

Bank for International Settlements (BIS)

Date Written: June, 2018


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{{p}}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.

JEL Classification: E31, E32, F44, F45

Suggested Citation

Gilchrist, Simon and Schoenle, Raphael and Sim, Jae W. and Zakrajsek, Egon, Financial Heterogeneity and Monetary Union (June, 2018). FEDS Working Paper No. 2018-43, Available at SSRN: or

Simon Gilchrist (Contact Author)

New York University (NYU) ( email )

Bobst Library, E-resource Acquisitions
20 Cooper Square 3rd Floor
New York, NY 10003-711
United States

Raphael Schoenle

Brandeis University ( email )

Waltham, MA 02454
United States

Jae W. Sim

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Egon Zakrajsek

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002

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