Stabilization mechanisms in a monetary union

The stability of a monetary union entails the establishment of mechanisms that allow the member countries to smooth their paths of consumption after negative shocks in their income. A centralized fiscal institution could help countries through a mechanism of taxes and transfers. In this paper we study the stabilizing effects of different mechanisms of compensation in a two-country general equilibrium model subject to asymmetric technology shocks. In particular, we have focused on an optimal system of taxes and transfers as opposed to a discretionary transfer mechanism, finding that the optimal transfer consists in an intertemporal distribution to the economy that experiences the negative shock instead of a current high transfer as in the non-optimal mechanism. Lastly, we have assessed the degree of stabilization related to the mechanisms in question, showing that the optimal mechanism can match the degree of stabilization the empirical literature attributes to the case of the United States.