Stabilizing Valences of an Optimum Monetary Zone in a Resilient Economy—Approaches and Limitations

Abstract

Following De Grauwe (2016), this research advances the idea according to which economies that are part of a monetary union issue debt in a medium of exchange they cannot control: financial markets develop the capacity to impose default on such economies. We are interested in how previous research analyzed the notion that, when economies are autonomous and they employ the exchange rate as a vehicle to handle asymmetric shocks, they confront comparable constraints on the performance of exchange rate strategies. When a monetary union is affected by significant asymmetric shocks, the member economies have to deal with tough adjustment issues. Empirical and secondary data are used to back the assertion that, in a monetary union, economies that are affected by long-lasting asymmetric demand shocks demand wage elasticity and labor flexibility to rectify for them, and if the latter generate substantial budget deficits, financial markets tend to intensify the consequences of the asymmetric shocks, boosting the demand for severe regulation of wages and labor flexibility. Our article makes conceptual and methodological contributions to the view that member economies of a monetary union are exposed to varying market reactions, generating more volatility in the business cycle: an economy undergoing a recession and a rise in the budget deficit might be affected by wide-ranging transactions of its government bonds, causing a liquidity crisis and superior interest rates, and possibly coercing the government of that economy to adopt budgetary austerity measures, thus intensifying the recession.