Can fixed exchange rate regimes cause output divergence among participating states? We show that such divergence is a long-run equilibrium characteristic of a two-region model with fixed exchange rates, heterogeneous labor markets, and endogenous growth. Under flexible exchange rates, region-specific monetary policies close output gaps and realize the associated maximum TFP growth in both regions. Upon fixing exchange rates, the common monetary policy pushes the region with higher wage inflation into a low-growth trap. When calibrated to the euro area, the model implies a slowdown in the TFP growth rate of the euro area's periphery relative to its core. Empirical tests confirm that countries with high wage inflation suffer lower TFP growth in the aftermath of fixing the exchange rate.

We estimate the contribution of the American precious metal windfall to West Europe’s growth performance in the early modern period. The exogenous nature of American money arrivals allows for identification of monetary effects. We find that more than half of West Europe’s growth can be attributed to American precious metals, whose arrival promoted trade intensification and capital formation. Our findings place West Europe’s second-stage receivers in a particularly fortunate goldilocks zone that enjoyed monetary injections, while being insulated against the transport-loss induced financial crises that caused persistent damage to first-stage receiver Spain.

In this paper, I investigate the role of interregional risk sharing arrangements in a monetary union when countries are afflicted with sovereign default risk. I introduce a sovereign default model in which regional sovereign default risk affects private sector financing costs and the linkage between public and private sector financing costs can exacerbate economic downturns. By providing insurance against such recessions, interregional risk sharing arrangements can raise average output levels, and thereby generate sizeable welfare benefits. Importantly, I show that most of the welfare benefits that are obtainable from the optimal risk sharing arrangement can be reaped by a standby facility that is easy to implement.