Testing the Viability of a Currency Union: A Panel Data Analysis for European Countries (1985-2002)

Abstract

Mundell (1961) claimed that the viability of a currency union relies on the degree of labour mobility. In the present paper an attempt is made to introduce a test for the viability of a currency union. To this end author will try to measure in European countries the relative real wage rigidity across countries as a result of the relative inflation across countries and the unemployment rate within countries. This model agrees with the conclusions of (Bauer et al., 2003) and according to Mundell (1961), author proposes that it can also be used first as a test for measuring labour mobility within currency unions, and second as a tool to test the viability of a currency union (which is the main contribution of the present paper). It will also be pointed out that under a perfect information regime unemployment declines, for labour mobility in European countries is globally perfect, as well as that workers accept to work at a lower real wage instead of staying unemployed. All econometric models in this paper using panel data are made feasible through the Eviews software package.