I study efficiency and optimal monetary policy in a two-country monetary union with frictional labor markets. With heterogeneity in labor market frictions, the constrained efficient allocation generically cannot be achieved even if productivity shocks affecting each country are the same. The second-best optimal policy targets smaller inflation and output gaps in the more sclerotic labor market. A quantitative calibration to the eurozone implies welfare gains from redefining the union's inflation target to put more weight on its sclerotic members.
"Optimal Currency Areas with Labor Market Frictions."
American Economic Journal: Macroeconomics,
Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
Price Level; Inflation; Deflation
International Monetary Arrangements and Institutions
Macroeconomic Issues of Monetary Unions