Working Paper: CEPR ID: DP660
Authors: Jorgen von Hagen; Manfred J. M. Neumann
Abstract: The renewed quest for a European monetary union raises the question: Is Europe ready for a common currency? We compare the variability and persistence of real exchange rate fluctuations within the German monetary union and between Germany and eight European countries to assess the viability of a monetary union in Europe. The results suggest a `Two-Speed Europe'. A core union comprising Germany and her smaller neighbours is currently viable, but further convergence to reduce real exchange rate variability between these core countries and Denmark, France, Italy, and the United Kingdom is necessary. Alternatively, monetary union should be postponed until further adjustment has occurred. This period of waiting would neither require nor benefit much from further tightening of the current EMS.
Keywords: exchange rates; economic integration; currency union
JEL Codes: F31; F33; F36
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| variability of real exchange rates (RER) between Germany and several European countries (F31) | challenges for a monetary union (F45) |
| higher remaining variance in RER between Germany and certain countries (F29) | challenges for a monetary union (F45) |
| asymmetric real supply and demand shocks (F41) | higher remaining variance in RER between Germany and certain countries (F29) |
| closer monetary policy coordination (E61) | reduction in variability of RER (C29) |
| exchange rate arrangements under the European Monetary System (EMS) (F33) | variability of real exchange rates (RER) (F31) |