The third and final phase of European Economic and Monetary Union (EMU) was successfully launched on January 1,1999, when the exchange rates of 11 participating countries were irrevocably locked, the European Central Bank (ECB) assumed responsibility for executing a unionwide monetary policy, and the euro was adopted as the common currency. Over a three-and-a-half-year transition period, the euro will gradually replace national currencies, with the transformation scheduled to be complete by July 1,2002, when the euro becomes the only legal tender for participating EMU countries. In a recent IMF Working Paper, Real Wage Rigidities, Fiscal Policies, and the Stability of EMU in the Transition Process, Norbert Berthold, Rainer Fehn, and Eric Thode, participants in the IMF Research Department's Visiting Scholar program, suggest that political considerations dominated the design and launch of EMU. They argue that the failure to take economic considerations into sufficient account could have serious consequences for the stability of EMU, particularly during the unsettled transition period.
An inherent problem with EMU from its inception, the authors note, is that although it is a monetary union and its members constitute a currency area, it does not fit easily into the standard definition of an optimum currency area. A well-functioning monetary union is characterized by one or more of the following features: low incidence of asymmetric shocks, a highly mobile labor force, flexible real wages, and a system of fiscal federalism. Even with these features in place, there is no guarantee of permanent stability. This is probably the principal reason, the authors observe, that monetary unions not accompanied by political unification always remain somewhat unstable.
The 11 participating EMU countries have widely varying production structures, so sector-specific shocks are bound to affect each country differently. This is not at all surprising, the authors note, considering that the prospective boundaries of EMU stretch from the Mediterranean to the Arctic Circle. Furthermore, given that the capacity to adjust to adverse shocks also differs considerably among countries, even symmetric shocks can be expected to exert asymmetric effects on member countries. Given the current economic and structural diversity of prospective member...