Focus on Central, Eastern and South-Eastern Europe
Edited by Ewald Nowotny, Peter Mooslechner and Doris Ritzberger-Grünwald
Chapter 11: Economic Divergence Within the Euro Area: Lessons for EMU Enlargement
Agnès Bénassy-Quéré, Antoine Berthou1 and Lionel Fontagné2 According to the optimum currency area theory (Mundell, 1961), the decision to form a monetary union should result from a trade-off between microeconomic gains and macroeconomic costs: ● ● Within a monetary union, uncertainty on bilateral foreign exchange rates as well as currency exchange transaction costs (bank charges associated with the exchange of goods and services, or capital transactions) disappear, and price transparency increases. An intensification of competition is expected, leading to price convergence and to an expansion of the volume of trade between members of the monetary union. The resulting welfare gains are all the more important as the extent of trade creation and price convergence is sizeable. Members of a monetary union by definition lose their monetary independence. This has no consequences if economic activity and price cycles are well correlated within the union. However, the loss of the monetary tool can be hard on countries affected by specific shocks. In this case, stabilization requires high international mobility of the production factors within the union, or a sizeable flexibility of relative prices, especially of real wages. However, the pros and cons of forming a monetary union also involve political-economy arguments such as coordination and/or credibility effects. A single currency is expected to eliminate non-cooperative behaviour when the union is hit by a symmetric shock (beggar-thy-neighbour policies). In countries with an inflationary tradition, the banishment of devaluation is also expected to efficiently anchor inflation expectations, thereby reducing the costs of...
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