One Money and Fifteen Needs Inflation and Output Convergence in the European Monetary Union
Van Poeck A.
In January 1999 the Economic and Monetary Union was established. The member countries abandoned their national currencies and adopted a common currency, the euro, and a common monetary policy. Adopting a common currency is supposed to bring a number of advantages to the member states of a monetary union, such as deeper product and financial market integration, increased trade and capital flows and ultimately increased growth. But by joining a monetary union, a country forgoes the ability to use domestic monetary policy to respond to country-specific macroeconomic disturbances. Monetary policy in a monetary union is the responsibility of the central monetary authority, in this case the European Central Bank (ECB). This central authority pursues monetary policy taking into account the overall situation in the union. Hence, for an individual country, the more its macroeconomic position is in line with the union’s average, the less the costs for that country of belonging to the union. Put differently, the more similarity between the individual countries belonging to a monetary union, the easier the task of the union’s central bank. One could even argue that the long run success and political viability of a monetary union depends on it. In this paper we analyze whether the ECB’s monetary policy has become more balanced towards the needs of the individual member states with the passage of time. We assume that the ECB’s monetary policy stance is in line with a Taylor rule and based on the overall situation in the Euro area, more specifically on the Euro area inflation rate and the overall business cycle position in the area. This assumption is confirmed by many researchers (see e.g. Breuss, 2002; Fourçans and Vranceanu, 2002, Sauer and Sturm, 2003, Ulrich, 2003). The question therefore boils down to investigating whether inflation and business cycles have converged since the start of the monetary union.
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