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The nature of shocks in Eurozone.

JEL F30 * F33

The frequency and nature of shocks impacting the individual member countries is one of the major factors determining the success of a monetary union. Starting with the seminal work of Robert Mundell (A Theory of Optimum Currency Areas, AER, vol. 52, November 1961), economic writers analyzed the varying roles symmetric and asymmetric shocks played in the optimality and success of currency unions both theoretically (the optimum currency areas (OCA) theory) and empirically.

The formation of the European Monetary Union (EMU) and the creation of the European common currency (Euro) brings forward the question of the nature of shocks faced by the EMU countries into a renewed focus. Most economists agree, at the moment of its creation in 1999, the EMU was not an OCA. But, some of the analysts, together with the European Commission, argued the adoption of the Euro would be the catalyst bringing the EMU member states closer to the OCA over time.

This paper endeavors to test the latter contention. The basic idea is the dynamics of the real effective exchange rates (REERs) in a single country reflect the impact of shocks to this country's economy. The variability of REERs among the Eurozone member countries then indicates the relative nature of these shocks. If this variability remains stable over time or even decreases, shocks are symmetric meaning all Eurozone members face similar shocks at the same time, leaving the relative REERs intact or even converging. Alternatively, if the variability of REERs increases, shocks are asymmetric implying different countries experience different shocks at different times.

The root mean squared deviation (RMSD) of the Eurozone countries REERs from the Eurozone-wide REER serves as the measure of variability. The Eurostat database reports REERs based on unit labor costs (variability denoted by RMSDULC) and on consumer price indexes (CPIs) (variability denoted by RMSDCPI). Additionally, the weighted RMSDs (RMSDWULC and RMSDWCPI) were constructed, weighting the deviations of REERs for individual countries by the share of this country's GDP in the Eurozone's total. These variability measures were calculated for the each quarter between 1999:1 and 2007:2. Resulting time series were tested for unit roots, using both Augmented Dickey-Fuller (ADF) and Perron tests. The hypothesis of no unit roots (the stationarity) was rejected in each case.

Subsequently, each time series was regressed on the constant and trend. The period from 2001:1 to 2007:2 was used in these estimations to account for both the optimum lags in the unit root tests and the delayed Greek accession to the Eurozone. The Beach-McKinnon ML estimator was used to account for a serial correlation. Results are as follows ([rho] is the coefficient of serial correlation; numbers in parenthesis are the relevant t-statistics):





The results of the unit root tests and the estimations above indicate the variability of the REERs among the Eurozone countries is non-stationary, with the tendency to increase over time, implying the asymmetric shocks dominate the symmetric shocks, at least when the competitiveness indicators like REERs are considered. It can therefore be concluded, since its inception, the Eurozone has not come closer to being an OCA in the Mundellian sense, which certainly should be of the interest to European authorities.

Published online: 15 June 2008

A. Rusek ([mail])

Susquehanna University, Selinsgrove, PA 17870, USA

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Title Annotation:ANTHOLOGY; real effective exchange rates
Author:Rusek, Antonin
Publication:Atlantic Economic Journal
Geographic Code:4E
Date:Sep 1, 2008
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