Killing two birds with one currency: Income and fiscal policies in a growth model of a currency union

Building on a two-country Kaleckian model of a currency union, we examine the consequences of balance-of-payments adjustment policies, focusing on the interdependence between the long-run growth paths of member countries. The model separates the short-run from the long-run dynamic, comparing price and wage dynamics in each country in the light of Thirlwall’s balance-of-payments-constrained growth model. We show that by shifting the burden of adjustment to the less competitive country, austerity and wage moderation policies lead to long-term recessionary effects. Only expansionary policies in the more competitive country can achieve the two goals of reducing external imbalances and increasing the long-run growth rate in both member countries.