Macroeconomic Adjustment to Monetary Union

41 Pages Posted: 20 Oct 2008

See all articles by Gabriel Fagan

Gabriel Fagan

European Central Bank (ECB)

Vitor Gaspar

European Commission

Date Written: October 16, 2008

Abstract

The move to monetary union in Europe led to convergence of interest rates among the participating countries. This was associated with notable cross-country differences in the behaviour of key macroeconomic aggregates. Compared to the low interest rate countries, former high interest rate countries experienced a boom in domestic demand, a deterioration of the current account and appreciation of the real exchange rate. This paper documents the key stylised facts of this experience and provides a compact two-country model, based on the Blanchard-Yaari setup, to analyze this phenomenon. This model, though simple, is able to broadly capture the main qualitative features of the adjustment. Using this model, we show that the creation of the monetary union leads to an increase in welfare for all generations in both country groups.

Keywords: euro area, interest rate convergence, overlapping generations model

JEL Classification: F36, E21, F32

Suggested Citation

Fagan, Gabriel and Gaspar, Vitor, Macroeconomic Adjustment to Monetary Union (October 16, 2008). ECB Working Paper No. 946, Available at SSRN: https://ssrn.com/abstract=1273544

Gabriel Fagan (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
0049 69 13440 (Phone)
0044 69 1344 6000 (Fax)

Vitor Gaspar

European Commission ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 7200 (Phone)
+49 69 1344 6575 (Fax)

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