Asymmetric Shocks and Monetary Policy in the Euro Area

We analyze the role of asymmetric macroeconomic shocks for conduct of monetary policy of the euro area, as a monetary union. Taking an international business cycle perspective, we distinguish between symmetric shocks, which affect countries similarly, and asymmetric shocks, which cause diverging movements across countries. Applying a Bayesian sign- and zero-restricted structural vector autoregression (BVAR) model, we find that global symmetric shocks predominantly drive business cycles in most euro-area countries. Linked to this, we find evidence of a euro-area-specific cycle. Through the lens of our framework, we also find empirical support for the optimum currency area (OCA) endogeneity hypothesis: upon adopting the euro, new member countries, on average, experience faster convergence in their share of symmetric shocks relative to the euro-area aggregate. Our econometric framework also allows us to derive an optimum currency area index for the euro area based on a shocks-similarity principle. Our index captures not only the relative importance of symmetric shocks but also the extent of cross-country heterogeneity. This OCA index highlights that, while the OCA features of the euro area remain firmly established, their further improvement has stagnated over time. All in all, current levels of the OCA index suggest a broadly similar level as at the start of the euro, underscoring the importance of not being complacent with the policy goal of EU single market integration.