European Monetary Union and Asymmetric Shocks in a New Keynesian Model.

This paper attempts to quantify the costs imposed by asymmetric shocks under European Monetary Union compared to free floating. A simple two-country model is examined where policy is set in an optimal, time consistent manner. Nominal and real rigidities are present in both economies, but prices are set in a forward looking manner and expectations are rational. Results suggest that the costs of asymmetric shocks under EMU may be significantly higher than under free floating, particularly if fiscal policy is not used for demand management. Copyright 1999 by Royal Economic Society.