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Quo vadis Eurozone? A reappraisal of the real exchange rate criterion

  • Kolev, Galina

In 1976 Vaubel suggested using the variation of real exchange rates when evaluating the desirability of a monetary union within a group of currencies (Vaubel 1976). Currency uni cation is less desirable, the more often real exchange rate adjustments are needed. Ten years later, Mussa reconsidered the high correlation between nominal and real exchange rate movements and presumed predominant influence of transitory factors on the development of real exchange rates (Mussa 1986). The implementation of the real exchange rate criterion for the viability of countries to form a monetary union a ords therefore to isolate the real exchange rate variation which is not caused by short-lived shocks to nominal exchange rates. Using the methodology introduced by Blanchard and Quah (1989), the present analysis examines the contribution of temporary and permanent shocks to the variation of real and nominal exchange rates among European countries. Imposing the restriction that temporary shocks should not a ect the real exchange rate in the long run, the analysis indicates that in most of the EU-15 countries the nominal exchange rate exibility has been used as a means to ful ll real exchange rate adjustments before 1999. Based on the results the most viable monetary union should be between Germany, Luxembourg, and France. Futher on, the empirical analysis applies the real exchange rate criterion to the Eastern enlargement of EMU and shows that giving up the nominal exchange rate exibility will be the most painful for Hungary and Poland.

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Paper provided by Verein für Socialpolitik / German Economic Association in its series Annual Conference 2012 (Goettingen): New Approaches and Challenges for the Labor Market of the 21st Century with number 66061.

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Date of creation: 2012
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Handle: RePEc:zbw:vfsc12:66061
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