The optimum currency area case for EMU: a structural VAR approach

In order to examine the optimum currency area case for EMU, we estimate structural VARs in output, the real exchange rate and prices for 14 EU countries and a small control sample. Using quarterly data since the end of bretton Woods, we find that (1) the data are strongly correlated for the majority of EU countries and the G6; (2) output and real exchange rate fluctuations are largely driven by real shocks; (3) primitive real and nominal shocks are no more correlated in absolute terms across the EU-core than the EU-periphery; (4) and G6 countries appear to be no less correlated than such a core; and (5) the response of output, real exchange rates and prices to identified IS and LM shocks are similar across all these economies. We are unable to answer the question of whether a group of countries constitute an OCA because we cannot gauge the required threshold of commonality. By examining rankings of correlations we are able to suggest, however, that a set of EU countries look relatively close to Germany but that this set look no closer to Germany than other large OECD economies.