EMU, Adjustment and the Peripheral Regions: An Overview of Policy Issues

Abstract

The potential effects of Economic and Monetary Union (EMU) and the single currency in Europe are of considerable importance not only to the core countries that might be joining from the very beginning, but also to the other countries that will be directly affected by the event. Countries that join EMU will benefit from lower transactions costs of foreign exchange and from increased macroeconomic stability brought about through greater monetary and fiscal discipline. Lower nominal interest rates will also be enjoyed in those countries and this will improve their inflation fighting credibility. Against these benefits, the main cost of EMU will be the loss of the exchange rate as a stabilisation policy instrument in the face of asymmetric shocks. This cost is particularly relevant to the peripheral regions that might have a different industrial and economic structure from that of the core countries joining EMU. This chapter tries to lay out the expected benefits and costs of EMU for the peripheral regions. After an analysis of the wide variation in GDP per capita that exists in the different regions of European countries, the chapter traces out the debate leading to the Maastricht convergence criteria. On the basis of the characteristics of an optimal currency area, the benefits and costs of EMU are then developed, followed by a discussion of the potential regional effects of EMU on Ireland. The challenges of fiscal policy in a monetary union are described, followed by the constraints of stabilisation policy under EMU. The chapter concludes with the case of greater cohesion funds within the European Union (EU) to ease the short-run costs of peripheral regions in their transition towards EMU.