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Is Europe an optimum currency area? A reconsideration of the evidence

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The main macroeconomic cost of a European Monetary Union could result from the loss of nominal exchange rate flexibility as an instrument for real exchange rate adjustments between regions exposed to asymmetric goods-market (IS) shocks. However, if asset-market (LM) shifts drive macroeconomic fluctuations, fixed exchange rates and for that matter European Monetary Union would stabilise the economy better than floating exchange rates. These considerations suggest that the choice of an exchange rate regime depends on whether the shocks affecting the economy are originated in the goods or money market. There is no doubt that identifying the incidence of shocks to aggregate demand (which simply aggregates goods and money market shocks) and aggregate supply shocks is inappropriate in deciding on the exchange rate regime. But, what is the nature of shocks across the main European member states? In particular, what is the relative importance of goods market (IS) shocks versus asset market shocks (LM) in the European Union? This is the question analysed in this paper.

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en

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http://eprints.lse.ac.uk/20346/

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