Working Paper: NBER ID: w23205
Authors: Tamim Bayoumi; Barry Eichengreen
Abstract: Once upon a time, in the 1990s, it was widely agreed that neither Europe nor the United States was an optimum currency area, although moderating this concern was the finding that it was possible to distinguish a regional core and periphery (Bayoumi and Eichengreen, 1993). Revisiting these issues, we find that the United States is remains closer to an optimum currency area than the Euro Area. More intriguingly, the Euro Area shows striking changes in correlations and responses which we interpret as reflecting hysteresis with a financial twist, in which the financial system causes aggregate supply and demand shocks to reinforce each other. An implication is that if the Euro Area wishes to avoid financial booms and busts it will need vigorous, coordinated regulation of its banking and financial systems by a single supervisor—that monetary union without banking union will be prone to economic and financial instability.
Keywords: Monetary Union; Hysteresis; Financial Regulation
JEL Codes: F0; F3; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Positive aggregate supply shocks (E23) | Increased lending and spending (E51) |
| Increased lending and spending (E51) | Positive aggregate demand shocks (E00) |
| Temporary demand shocks (E39) | Permanent supply shocks (Q31) |
| Financial system in the euro area (G21) | Supply and demand shocks reinforce each other (E32) |
| Monetary union without banking union (F36) | Economic instability (E32) |
| Increased correlations between shocks in Germany and GIIPS countries (F65) | Causal relationship driven by financial cycle (E32) |