Is Europe an Optimum Currency Area? Evidence on the Magnitude and Asymmetry of Common and Country-Specific Shocks in 20 European Countries

Abstract

This paper asks whether Europe is an optimum currency area. Economic theory suggests that a common currency is more likely to be beneficial if coun try-specific shocks are mild and symmetric, whereas in the presence of major asymmetric shocks, floating exchange rates are more likely to be stabilizing. Using annual data from the 1950-1990 period, real output fluctuations of 20 European countries (the 15 current members of the European Union, and 5 prospective members) are decomposed into common and country-specific shocks. The decomposition reveals that country-specific shocks in Europe (and the European Union) are both large and asymmetric. These results imply that a common European currency (despite its political attractiveness and poten tial credibility gains) will have very few stabilization benefits. (JEL Classified tion: E42, F36, F42)

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