European Monetary Union
Adjusting to shocks

Proposals for a European currency union have generated an upsurge in interest in behaviour across regions within the US. If European countries do relinquish their own currencies, they will face many of the same constraints faced by US regions. By analysing regional behaviour in the US, a large economy with a single currency, researchers hope to shed light on the potential effects of a single currency in Europe. In Discussion Paper No. 1172, Research Associate Tamim Bayoumi and Eswar Prasad examine sources of disturbances to output and labour market adjustment in the US currency union compared to a set of EU countries.

Comparable datasets comprising one-digit sectoral data for eight US regions and eight European countries are constructed and used to study the relative importance of industry-specific, region-specific, and aggregate shocks to output growth. Both areas are subject to similar overall disturbances although a disaggregated perspective reveals some differences. The major difference, however, is in labour market adjustment. Inter-regional labour mobility appears to be a much more important adjustment mechanism in the US, which has a more integrated labour market than the EU. This could either be because of, or reflecting, the single currency, and that inter-regional flows of labour constitute an important adjustment mechanism in the US labour market. In Europe, while flows of labour across sectors within countries may be important, labour flows across countries do not seem to be an important adjustment mechanism. This implies that large wage differentials across European countries could remain after EMU. In addition, unless labour mobility across European countries is enhanced, wage differentials across countries will have to remain flexible if significant disruptions from country-specific disturbances are to be avoided in EMU.

Currency Unions, Economic Fluctuations and Adjustment: Some Empirical Evidence
Tamim Bayoumi and Eswar Prasad

Discussion Paper No. 1172, May 1995 (IM)