Fidrmuc, Jarko; Korhonen, Iikka --- "Optimal currency area between the EU and accession countries: the status quo" [2003] ELECD 17; in Tumpel-Gugerell, Gertrude; Mooslechner, Peter (eds), "Economic Convergence and Divergence in Europe" (Edward Elgar Publishing, 2003)

Book Title: Economic Convergence and Divergence in Europe

Editor(s): Tumpel-Gugerell, Gertrude; Mooslechner, Peter

Publisher: Edward Elgar Publishing

ISBN (hard cover): 9781843762416

Section: Chapter 11

Section Title: Optimal currency area between the EU and accession countries: the status quo

Author(s): Fidrmuc, Jarko; Korhonen, Iikka

Number of pages: 22

Extract:

11. Optimal currency area between the
EU and accession countries: the
status quo
Jarko Fidrmuc and Iikka Korhonen

11.1. INTRODUCTION1

In this chapter, we examine the correlation of supply and demand shocks
between the Central and Eastern European countries (CEECs) and the
euro area. Our purpose is to assess whether the accession countries belong
to the same optimum currency area as the current members of the mone-
tary union. At the same time, we use data from the 1990s to assess the sim-
ilarity of the shocks within the euro area. This is the first attempt to assess
the similarity of shocks vis-à-vis the euro area, as previous studies have
almost uniformly concentrated on correlation with German (the `core'
country) shocks.
In practice the supply and demand shocks are recovered from two-vari-
able (output and inflation) vector autoregressive (VAR) models with the
help of the decomposition developed by Blanchard and Quah (1989). The
different shocks are identified from the VAR residuals with the help of the
restriction that demand shocks cannot have a permanent effect on output.
The same procedure has been used before to assess whether the current
European monetary union constitutes an optimum currency area, for
example by Bayoumi and Eichengreen (1993). Our contribution also
updates their results (although with quarterly data), and we find that in
general shocks in the member countries of the euro area are quite highly
correlated. Moreover, countries like Italy, which were deemed `peripheral',
have become more integrated with the ...