European Monetary Union, Asymmetric Shocks and Inertia

This paper assesses the scale of the costs of European Monetary Union when shocks are asymmetric. This is done considering time consistent policies within a small theoretical two country model, with parameter values chosen from empirical work. The model builds on earlier work by incoporating a forward looking inflation mechanism. Our results suggest that there are significant costs associated with Monetary Union, particularly when fiscal policy is not used as a stabilisation tool.