Working Paper: CEPR ID: DP9233
Authors: Zeno Enders; Philip Jung; Gernot Müller
Abstract: In contrast to the notion that the exchange-rate regime is non-neutral, there is little evidence that EMU has systematically changed the European business cycle. In fact, we find the volatility of macroeconomic variables largely unchanged before and after the introduction of the euro. Exceptions are a strong decline in real exchange rate volatility and a considerable increase in cross-country correlations. To account for this finding, we develop a two-country business cycle model which is able to replicate key features of European data. In particular, the model correctly predicts a limited effect of EMU on standard business cycles statistics. However, further analysis reveals that the euro has changed the nature of the cycle through its impact on the transmission mechanism. Cross-country spillovers have become relatively more, domestic shocks relatively less important in accounting for economic fluctuations under EMU. This explains why there is little change in unconditional volatilities.
Keywords: cross-country spillovers; EMU; euro; European business cycles; exchange rate regime; monetary policy; optimum currency area
JEL Codes: E32; F41; F42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| introduction of the euro (F36) | decline in real exchange rate volatility (F31) |
| introduction of the euro (F36) | increase in cross-country correlations of output and other macroeconomic aggregates (F62) |
| country-specific shocks (F69) | prominence in impact on economic fluctuations within the euro area (F44) |
| domestic shocks (E32) | less influential on economic fluctuations (F69) |
| introduction of the euro (F36) | shift in the transmission of shocks (C22) |
| shift in the transmission of shocks (C22) | stronger cross-country spillovers from country-specific shocks (F69) |
| common monetary policy and reduced real exchange rate responses (E52) | stronger cross-country spillovers from country-specific shocks (F69) |