Losses from Membership in EMU: An Estimated Two-Country DSGE Model

This paper analyzes how adoption of the euro would affect the volatility of output and inflation in the presence of asymmetric shocks. In addition, we investigate whether changes in the objective function of the ECB, or more or less active fiscal policy, can decrease losses entailed by EA membership. Overall, results indicate that a membership would decrease EA losses but increase the new member's losses significantly. However, output variability is shown largely to decrease, a fact which can be explained by the disappearance of the exchange rate. Furthermore, results indicate that automatic stabilizers and flexible inflation targeting can play an important role in reducing these losses.