Should I stay or should I go? An agent-based setup for a trading and monetary union

Abstract

The recent history of the European Union (EU) suggests the importance of studying the conditions under which two or more countries can benefit from becoming part of a union. Of course, this depends both on the economic characteristics of the involved countries and on the scope of the union, i.e., the level of integration of markets, regulations, and institutional bodies. This study tackles the topic from the angle of agent-based computational economics, by designing an open-economy model, inspired from the EU, where countries can be part of a trade and monetary union. We find that, for similar countries, it is always beneficial to be a member of a union, although a lack of mobility frictions can cause a divergence between the two countries, weakening the overall union performance. Even if countries have different productivity, the performance of the union is in general better than the performance of the isolated countries. The exception is when productivity gap and labor mobility are both high. In this case, a strong migration within the union can create economic distortions, exacerbating the gap between the member states. Stronger fiscal integration helps reducing inequality between countries, increasing the sustainability of the monetary union.