FINANCIAL MARKET INTEGRATION AND BUSINESS CYCLE VOLATILITY IN A MONETARY UNION

This paper uses a dynamic general equilibrium two‐country sticky‐price model to analyze the implications of financial market integration for the propagation of asymmetric productivity and government spending shocks in a monetary union. Financial market integration has a small effect on the propagation of these shocks if households can only trade in risk‐free bonds. However, financial market integration has a more substantial effect on the propagation of these shocks in a monetary union with a complete market for state‐contingent claims. This result indicates that it may be important to account for threshold effects in empirical analyses of the impact of financial market integration on business cycle volatility in a monetary union.