OPTIMUM CURRENCY AREAS AND EUROPEAN MONETARY UNIFICATION

Abstract

This paper examines the European experience from optimum currency areas perspective with a focus on the correlation of underlying aggregate shocks within a structural vector autoregression (VAR) framework. Appropriately identifying supply shocks, real fiscal shocks, and nominal shocks, the paper investigates the correlations of shocks and tries to evaluate the likely adjustment and other problems that may take place with the introduction of a single currency in Europe. Using data for 20 European market economies, the paper compares original members of the European Community to new members and non‐members. Shocks are mostly country‐specific, particularly for newer members and non‐members, suggesting the importance of alternative adjustment mechanisms other than national monetary policies after the introduction of a single currency.