Unstable Monetary Unions - the Role of Expectations and Past Experience

This paper presents a theoretical model that captures the importance of economic experience prior to joining a monetary union for the stability of the country joining. I introduce informational frictions in the form of learning into a model of a monetary union and study how those frictions interact with different economic histories. The model predicts that countries joining the union face the risk of persistent current account imbalances. The risk is amplified when the country experienced high inflation prior to joining the union. This suggests that pre-euro heterogeneity in country-specific inflation experience may shed light on the buildup of imbalances within the Eurozone. I support this claim with empirical patterns of pre-crisis variables in the Eurozone countries