Working Paper: CEPR ID: DP1481
Authors: Maria Demertzis; Andrew J. Hughes Hallett; Ole J. Rummel
Abstract: The Treaty of Maastricht requires that by 1 January 1999, at the latest, there shall be a nucleus of a monetary union. The issue of monetary union must therefore rest on the presumption that a small ?credible? group of countries that fulfils the convergence criteria will be able to adopt a single currency, while the remaining peripheral countries will continue to use their national monetary instrument until monetary convergence is attained. In this paper we accept the core/periphery distinction as given and evaluate the conditions under which it is sustainable. We approach the issue through the literature on optimal currency areas and concentrate on the importance of countries hit by symmetric shocks of similar size. We adopt the Bayoumi and Eichengreen methodology of examining correlations of shocks within and between groups and discover that, while the split as is currently understood may be justified, the core is no more an optimal currency area than the periphery. A monetary union based on strict monetary rules, as implied by the German model of monetary control, is better applied to a much narrower range of countries than the core currently includes; extending the union beyond that narrow set under German-style monetary controls would be to create a very fragile union held together by other types of compensating stabilization policies.
Keywords: EMU; two speeds; optimal currency areas; random shocks
JEL Codes: F15; F33; R11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Division of European countries into core and periphery (F55) | Justification of the division (Y20) |
| Monetary union based on strict monetary rules (F36) | Applicability to a limited range of countries (O57) |
| Extension of monetary union beyond limited range of countries (F36) | Fragile union (D74) |
| Structure of economic shocks (E32) | Effectiveness of monetary policy (E52) |
| Internal symmetry of core countries (F12) | Lack of sufficient similarity in shock responses compared to periphery (C59) |
| Asymmetries in impulse responses to economic shocks (F41) | Complication of unified monetary policy implementation (E61) |
| Costs associated with monetary union (F36) | Variation depending on dominance of demand vs. supply shocks (E39) |
| Costs associated with monetary union (F36) | Variation depending on degree of flexibility in labor markets (J29) |