The European Monetary Union: were there alternatives to the ECB? A quantitative evaluation

There is a large and growing literature on the benefits and cost of European Monetary Union (EMU) in Europe. Much of the literature is theoretical in nature with very little empirical evaluation of the magnitudes of effects. This paper places some quantitative magnitudes on the scale of some issues in European monetary integration. It uses the European version of the MSG2 multicountry model to evaluate the variance of a number of European variables in the faces of shocks to money markets, fiscal policy, and total factor productivity under three alternative European monetary regimes: (1) an EMU with a European Central Bank (ECB) setting monetary policy, (2) the earlier European Monetary System (EMS), and (3) a system of floating exchange rates within Europe. For each type of shock, we consider the adjustment to global shocks, European-wide shocks, shocks in Germany, and shocks in Europe excluding Germany. Within the constraints of each monetary regime, we allow any unconstrained monetary instruments to be set either cooperatively between European countries and noncooperatively where each country is allowed to set their policy instruments to maximize an objective function. We find that no monetary regime consistently dominates for all shocks, and regimes are ranked differently across European economies for the same shock. Abstracting from the serious question of policy credibility, this suggest that maintaining some flexibility in the setting of monetary policy in countries could potentially be invaluable to facilitate smooth adjustment to global, regional, and country specific shocks. (C) 2001 Society for Policy Modeling. Published by Elsevier Science Inc.