ON THE POSSIBLE COSTS OF EUROPEAN MONETARY UNION

Abstract

Much has been written about the benefits of monetary union in Europe, but little about the possible costs. This paper use s a small simulation model to analyze the costs and best design for EMU. The authors find demand/supply asymmetries cause inflation, output losses and extra adjustment costs. Price stability requires tougher monetary controls, while output stability is critically dependent on active (and coordinated) fiscal policies. Thus the key is to increas e the effectiveness of existing policies. EMU itself adds very little since exchange rate stability cannot guarantee either price or outpu t stability. Relative price discipline is achieved at the expense of output stability and absolute price discipline. Copyright 1993 by Blackwell Publishers Ltd and The Victoria University of Manchester