Assessing the effects of financial heterogeneity in a monetary union a DSGE approach

The aim of this article is to analyze how financial heterogeneity can accentuate the cyclical divergences inside a monetary union that faces technological, monetary, budgetary and financial shocks. To this purpose, this study relies on a two-country Dynamic Stochastic General Equilibrium model, where the two countries are supposed to be differently sensitive to the bank capital channel. The model allows us to demonstrate how a given symmetric shock causes cyclical divergences inside a heterogeneous monetary union. On this point, it allows reproducing some stylized facts recently observed in the Euro Area. Moreover, it appears that the more heterogeneous the union, the larger the effects of financial asymmetries on the transmission of shocks. Finally, we show that a common monetary policy contributes to worsen cyclical divergences, in comparison with monetary policies that would be nationally conducted. ► We develop a two-country DSGE monetary union model. ► The model integrates heterogeneous banking systems as in the Euro Area. ► Some stylized facts recently observed in the Euro Area are reproduced. ► Shocks worsen the cyclical divergences in the union via the bank capital channel. ► A common monetary policy contributes to worsen cyclical national divergences.