Estimated Stabilization Costs of the EMU

A multicountry econometric model and stochastic simulation are used to estimate the stabilizntion costs of the European Monetary Union (EMU). A measure of the variability of output and other variables is computed for the wnent regime and for the EMU reeime. The results show that Germanv is hurt the most in terms of increased output variability in moving from the current regime to the EMU regime. 1. Introduction When different countries adopt a common currency, each gives up its own monetary policy. In the common-currency regime monetary policy responds to a shock in a particular country only to the extent that the common monetary authority responds to the shock. If this response is less than the response that the own country's monetary authority would have made in the pre common-currency regime, there are stabilization costs of moving to a common currency. This article estimates the stabilization costs to Euro-pean countries of adopting a common currency. The multicountry econometric (MC) model in Fair (1994) and stochastic simulation are used for this purpose. Variability estimates are computed for the current regime and for the regime that is assumed to exist if a common currency is adopted. " ' The question that this article attempts to answer is a huge one, and the present results are at best exploratory. In order to answer this question one needs 1) an estimate of how the current world economy operates, 2) an estimate of how it would operate if the European countries adopted a common currency, and 3) an estimate of the likely shocks to the world economy. Each of these estimates in this article is only an approximation, and work with other approximations is needed before much confidence can be placed on the current conclusions. The main aim of this article, aside from presenting some initial cost estimates, is to propose a methodology for answering this question. There is a rapidly growing literature on analyzing the economic consequences of a common European currency. Wyploz (1997) provides a useful recent review. Much of this literature is in the Mundell(1961), McKinnon (1963), and Kenen (1969) framework and asks whether Europe meets the standards for an optimum currency area. The questions asked include how open the countries are, how correlated individual shocks are across countries, and the degree of labour mobility. There is also recent work exam