This chapter addresses the claim that, without a fiscal federation, some EU member states will be unable to deal adequately with asymmetric shocks under a single currency because prices and wages are insufficiently flexible and European labour mobility too limited to compensate for the loss of the exchange rate tool. Fatás explores the US example, where the automatic interregional transfers that take place through the federal budget play an insurance role that compensates for the lack of internal exchange rates. Although estimates of the benefits of these transfers in the United States are large, Fatás finds the benefits from a European fiscal federation would be too modest to compensate for the problems that such an arrangement would create.

The authors examine the rationale and likely effects of the Stability and Growth Pact for the EU and conclude that it is both unnecessary and potentially harmful. The objective of preventing excessive public debt levels can be achieved through alternative mechanisms. The Pact’s main drawback is that it shifts the attention of policy-makers away from much-needed structural reforms in dealing with unemployment and the effects of an ageing population on the welfare system.

The authors question previous estimates of asymmetries in monetary transmission across potential EMU members, relate their own estimates to differences in financial structure, and discuss the implications for a common monetary policy. This will involve three challenges: treading the narrow path between an institutional revolution and continuity of the Bundesbank's approach; stabilizing prices on a broad European – rather than a national or regional – front; and getting to grips with the cross-country differences in financial and wage-price structures and processes.

This chapter draws on comparative analyses of internal North American (United States and Canada) and European adjustment patterns to asymmetric macroeconomic shocks for indicators to the future handling of similar shocks under EMU. Changes in regional real exchange rates are found to be small in all countries, but outside the United States there is more reliance on inter-regional transfer payments than on labour migration, and the pace of regional adjustment appears to be slower. The authors propose a strategy for achieving income redistribution within the EU and suggest measures which might make EMU more attractive to its detractors.

This chapter provides an analytical framework for assessing the potential international role of the euro. Portes and Rey use a new model and new data to assess how far the euro will assume 'reserve currency' status. They measure the effects of alternative scenarios on welfare in the main world regions, consider the implications for the financial asset and forex markets as the international monetary system adjusts to the euro, and propose policies for dealing with the potential for instability during the transition period.

Although the potential for the euro to challenge the global dominance of the dollar in the denomination of international trade in goods and financial assets has been much discussed, hitherto little attention has been paid to its likely role vis-à-vis the dollar in the global market for a safe, reliable vehicle currency. Rogoff argues that there are good reasons why citizens in developing countries will find the euro an attractive alternative currency to the dollar, but that there may be hidden dangers for Europe in playing this role, not least because the issue of large-denomination euro notes may facilitate tax evasion and illegal activities at home.

This chapter seeks to draw lessons for EMU from the European experience of the gold standard. The authors conclude that, under the gold standard, debts mattered and stability depended on the underlying price trend. Their analysis highlights the potential dangers of an overly restrictive policy stance by the ECB; the fragility of institutions in the face of deep public finance difficulties; the risks for the single market of leaving out countries that have not fully converged; the existence of a virtuous cycle of low interest rates, fast growth and debt reduction; and the importance of finding a proper balance between discipline and incentives.

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