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In Discussion paper No 1303 Research Affiliate Roel Beetsma and Research Fellow Lans Bovenberg explore under what conditions a European Monetary Union (EMU) is an optimum currency area. The scope for an EMU increases with convergence of structural and fiscal policies, small money holdings, a conservative European Central Bank, and dependent national central banks. The paper explores the rationale for constraints on national policies from the point of view of the strategic interaction between monetary and fiscal policy-makers. The analysis incorporates several channels through which national fiscal policies interact with the common monetary policy in an EMU. The analysis reveals that such an imperfect world provides a case for both entrance criteria involving the convergence of fiscal policies and surveillance of national policies once the Union has been formed.In stressing the need for convergence in fiscal and structural policies, the authors extend the literature on optimum currency areas. They focus on international differences in monetary and labour market institutions as well as public spending needs. Their analysis reveals that the size of an optimum currency area depends on the initial position of the central bank vis-à-vis the government, the degree of conservatism of the European Central Bank (ECB), the importance of seigniorage, and differences in structural policies (public indebtedness, labour market flexibility and the efficiency of the tax system) as reflected in the so-called government financing requirement. Designing Fiscal and Monetary Institutions for a
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