Does One Size Fit All? A currency union with asymmetric transmissions and a stability pact

The theory of optimal currency areas stresses that a single currency zone should have symmetry across shocks and structures. What happens if the monetary transmission mechanisms differ so that a common monetary policy has different effects in different places? Using a fully specified econometric model, we find that such asymmetries are likely to destabilise the business cycle and put countries out of phase with each other in a way that cannot be corrected by deficit-constrained national fiscal policies. Market discipline, however, could achieve this. Hence, the question is whether the markets would create sufficient discipline on their own.