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Labor Immobility and the Transmission Mechanism of Monetary Policy in a Monetary Union
E31 - Price Level; Inflation; Deflation
E41 - Demand for Money
E58 - Central Banks and Their Policies
E62 - Fiscal Policy; Public Expenditures, Investment, and Finance; Taxation
It is believed that a shock, common to a set of countries with identical fundamentals, has identical outcomes across countries. We show that in general, when specialization in production is such that a common shock creates a missing role for labor mobility across countries, the terms of trade of any country reacts to the shock. This is the case even if state contingent assets can be traded across countries. The transmission mechanism of a monetary shock in a monetary union has in this case an additional channel, the terms of trade. We also show that the country outcomes are significantly different, when compared with the effect of the shock on the union’s aggregate. Monetary shocks impose cycles with higher volatility in "poor" countries relatively to the volatility of "richer" ones.