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Macroeconomic Differentials and Adjustment in the Euro Area

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  • Iulia Traistaru-Siedschlag

    (Economic and Social Research Institute (ESRI))

Abstract

There has recently been increased research and policy interest in the divergent macroeconomic performance in the European Economic and Monetary Union (EMU). Understanding the underlying factors of macroeconomic differentials, the source and transmission of shocks and the adjustment process in the euro area is important to appropriate economic policy in the EMU. In a monetary union, the single monetary policy can only address common shocks. In the absence of nominal interest and exchange rates as policy instruments, to adjust to asymmetric shocks – country specific shocks or idiosyncratic effects of common shocks, member countries have to resort to remaining tools of economic policy. In theory, the adjustment to asymmetric shocks and return to equilibrium can take place through four channels: a) market – driven price and output adjustment; b) policy induced fiscal adjustment; c) risk-sharing against country-specific shocks through fiscal transfers and financial integration; d) labour mobility. Temporary inflation and output growth differentials are likely in a common currency area since prices and output adjustment is required to absorb shocks. In the euro area, output growth and inflation differentials are also related to the ongoing catch - up process in some of the member countries. Persistent inflation differentials can have negative effects on incomes and investment and result in divergent competitiveness and monetary conditions in the participating countries. Furthermore, inappropriate use of national fiscal policy and real exchange rate adjustment can lead to poor macroeconomic performance. The objective of this paper is to analyse macroeconomic differentials and the adjustment in the euro area so far with the aim to draw lessons and policy implications for the better functioning of the EMU and euro areaenlargement. The questions we address are the following: What do we know about macroeconomic differentials in the euro area? Are they temporary or persistent

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Paper provided by Economic and Social Research Institute (ESRI) in its series Papers with number WP175.

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Length: 38 pages
Date of creation: Oct 2006
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Handle: RePEc:esr:wpaper:wp175

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Cited by:
  1. Bergin, Adele & Conefrey, Thomas & FitzGerald, John & Kearney, Ide, 2009. "Recovery Scenarios for Ireland," Research Series, Economic and Social Research Institute (ESRI), number RS007.
  2. Cristina Puiu, 2011. "Labour Mobility As An Adjustment Mechanism In The Euro Area," CES Working Papers, Centre for European Studies, Alexandru Ioan Cuza University, vol. 3, pages 579-591, December.
  3. Traistaru-Siedschlag, Iulia, 2007. "Macroeconomic Adjustment in Ireland under the EMU," Quarterly Economic Commentary: Special Articles, Economic and Social Research Institute (ESRI), vol. 2007(1-Spring), pages 78-92.
  4. Andrzej Toroj, 2009. "Macroeconomic adjustment and heterogeneity in the euro area," National Bank of Poland Working Papers 54, National Bank of Poland, Economic Institute.

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