If the current timetable for EMU is observed, the transition will be complete by the end of the decade, but the sacrifice of monetary autonomy and its implications for countries seeking to respond to country-specific shocks are still worrying some governments. Monetary policy facilitates adjustment to disturbances, so adjustment problems may become more persistent and difficult to resolve, and limits on the use of fiscal policy resulting from the completion of the internal market reinforce these concerns.

In Discussion Paper No. 643, Tamim Bayoumi and Research Fellow Barry Eichengreen follow Mundell in viewing the incidence of asymmetric disturbances across regions as a critical determinant of the design of currency areas. They compare shocks in US regions and EC member countries to assess how monetary unification and the `1992' programme will affect responses to such shocks, using time-series data on real GDP and prices for 11 EC member states to assess the extent of aggregate supply and demand disturbances. If supply shocks are less correlated across US regions than across EC members, asymmetric shocks need not threaten EMU, while if US regions respond more quickly than European countries, the creation of an integrated market may encourage factor mobility and the creation of mechanisms that facilitate adjustment to shocks.
Bayoumi and Eichengreen find that both supply and demand shocks to the `core' countries Germany and its immediate neighbours are smaller and more correlated than those affecting the `peripheral' countries, and there is little evidence that the distinction between core and periphery is becoming less pronounced over time. They report a similar core and periphery in the US, but shocks affecting these two regions are more coherent than those in Europe. US regions also adjust more quickly to both demand and aggregate supply shocks than European countries, which may reflect greater factor mobility.

These results indicate that the European Community may find it more difficult to operate a monetary union than the US. Large idiosyncratic shocks strengthen the case for policy autonomy, while completing the internal market may heighten regional economic specialization, magnifying another source of shocks. The strong distinction between core and periphery in the Community lends support to arguments for a two-speed monetary union. The core experiences shocks of approximately the same magnitude and coherence as US regions, so Germany and its immediate neighbours may form a much more workable monetary union along US lines than the Community as a whole.

Shocking Aspects of European Monetary Unification
Tamim Bayoumi and Barry Eichengreen

Discussion Paper No. 643, May 1992 (IM)