Labour Market Asymmetries and Shock Absorption in a Monetary Union: Are Government Coalitions Effective?

Given a monetary Union which is heterogeneous at the level of labour market flexibility, this paper investigates the effects in terms of macroeconomic stabilization of the different degrees of fiscal coordination between governments. We use a static Keynesian model within a closed monetary Union and we introduce an intermediate level of coordination between the national governments, which is the variable geometry coordination between economic clubs consisting of structurally close countries. The distinction between the wide Unions welfare and each country members individual welfare proves that the effectiveness of a variable geometry fiscal coordination mainly depends on the type of the economic shocks affecting the Union members, the nature of the fiscal spillovers, and the extent of the Unions structural heterogeneity. While this type of game is effective in neutralizing the demand shocks, it doesnt manage to improve the national protection of all the country members against the supply shocks.