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N°1997 - 03 |
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| March |
| Symmetry and Asymmetry of Supply and Demand
Shocks in the European Union |
| Laurence Boone |
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A couple of years before the start of EMU,
there is still no agreement on the state of convergence of European economies,
nor on the scale of the costs and benefits of a monetary union. The literature
has discussed these issues based on the Optimal Currency Area Theory (see Mundell
(1961), Mac Kinnon (1964) and Kenen (1969)). The main idea is that the countries
gathering in a monetary union will face adjustment costs due to differences in
their economic structure. The more similar economic structures are, the less will
be these costs. The usual practice to measure the (potential) structural similarities
is the following: first, to estimate macroeconomic shocks (such as demand and
supply shocks) faced by the various countries of interest over a certain period
of time, and second to compute the correlation coefficient between two countries'
series of shocks. A high correlation coefficient is then meant to provide evidence
on a high degree of symmetry of economic structures across countries.
This approach assumes stable correlation coefficients over the given sample period, which requires at least two strong hypotheses:
1. there is no evolution in the structure of European economies over the last thirty years. This means that convergence must have taken place before the beginning of the sample period;
2. no extraordinary event is taking place over the period. For example, German reunification is assumed to have only had a temporary effect on the symmetry of structures between the countries of interest.
This is very unlikely to be the case. There has been German reunification which must have significantly disturbed the relationships between Germany and its European partners. Furthermore, the ERM, the Single Market Act and all the reforms implemented by European countries to induce greater integration between themselves must have -at least- speed up and deepened the process of integration. Overall, there is no reason why the above correlation coefficient should be constant over the last 30 years.
This paper uses a sophisticated econometric technique that allows one to get a dynamic measure of the evolving symmetries between European economies, as well as taking into account structural changes. First supply and demand shocks are estimated using VAR analysis (see Bayoumi and Eichengreen, 1996). Then the correlation between two countries' series of shocks is dynamically measured. This allows us to provide evidence about the evolution of convergence between the fifteen members of the EU.
The results are in line with previous research in the sense that they provide evidence of increasing integration among the " core " countries (France, Belgium, Austrian and the Netherlands). Furthermore, the paper goes beyond this simple evidence in several ways. Regarding supply shocks, Italy and Spain display a pattern of disturbances that looks increasingly similar to that of Germany, up to a point where it reaches the same degree of similarity as the core countries do with Germany (which is not the case in the rest of the peripheral countries). On the other hand, the paper also shows that despite greater integration within core countries, the direction of the integration process has always been focused on Germany alone. The " core " is not an attractive force for the rest of the European Union, including Germany. Hence, there is a strong asymmetry in the way European economies are converging. Finally, the paper draws policy implications for the building of EMU. |
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