Is Europe an Optimum Currency Area?

Is Europe an Optimum Currency Area? Business Cycles in the EU

This paper aims to assess whether the EU is an optimum currency area (OCA) by examining synchronization of business cycles and long-run output linkages in the EU countries. We argue that a necessary condition for the desirability of EMU membership for national economies is that the degree of persistence of shocks affecting them should be similar Given the low power of unit root tests, we measure the relative importance of permanent versus transitory components in output. The existence of a European business cycle is confirmed by correlation and cointegration analysis respectively. Finally, it appears that monetary coordination, by reducing exchange rate volatility, results in more synchronised cycles. EMU is therefore likely to be a successful experience, since the benefits of monetary integration will outweigh the costs of surrendering the exchange rate instrument. (JEL Classification: E42, F36, F42)