Files
Abstract
How will countries handle idiosyncratic national macroeconomic shocks under the European
single currency? The ways in which European countries now react to internally asymmetric
shocks provide a better forecast than do the regional response patterns of the United States. In
this paper we compare the US with Germany, Italy, the United Kingdom, and also with
Canada, which is closer to Europe than the US is in its labor market and fiscal institutions.
Europe's (and to some extent Canada's) model of regional response differs from that of the
US. Changes in relative regional real exchange rates are generally small. Outside of the US,
however, there is more reliance on interregional transfer payments, less on labor migration,
and the pace of regional adjustment appears slower. The regional adjustment patterns
currently prevailing within European currency unions—characterized by limited labor mobility
and price inflexibility--seem likely to prevail at the national level under the single currency. If
EMU aims to attain the economic and social cohesion of its constituent nations, it therefore
may be hard to resist the eventual extension of existing EU mechanisms of income
redistribution--a transfer union. We propose an alternative strategy based on a relaxed stability
pact, further strictures against central EU borrowing, labor market and fiscal reform, and the
issuance by individual member states of debt indexed to nominal GDP.