Introduction

Monetary unification promises to revolutionize the conduct of macro-economic policy in Europe. Countries previously free to pursue independent monetary policies will be forced to toe a common line. New constraints will be placed on the conduct of fiscal policy, whether the monetary union treaty incorporates explicit ceilings on budget deficits or governments are simply precluded from printing money to finance public spending. Economic and Monetary Union, or EMU, insofar as it entails a loss of policy autonomy, may involve real economic costs as well as the convenience and efficiency gains of transacting in one rather than several national currencies.

In his seminal article on optimum currency areas, Mundell (1961) identified two criteria useful for evaluating such costs. The first is the incidence of shocks. If disturbances are distributed symmetrically across countries, a common policy response will suffice. In response to a negative aggregate demand shock, for example, that is common to all EMU countries, a common policy response in the form of a simultaneous monetary and/or fiscal expansion may be all that is required. Only if disturbances are distributed asymmetrically across countries will there be occasion for an asymmetric policy response and may the constraints of monetary union bind.

The second criterion identified by Mundell is the extent of labor mobility. The more mobile is labor the less is the need for different policy responses to prevent the emergence of regional problems.