Exchange rate systems and macroeconomic stability

We examine macroeconomic stability and the properties of the international transmission of business cycles under three exchange rate systems: a flexible, a unilateral peg (EMS) and a single currency (EMU). The subjects of study are Germany and France. In France, macroeconomic volatility under EMU is comparable to that under a flexible exchange rate system but considerably lower than that under EMS. In Germany, output volatility is significantly higher under EMS-relative to the flexible regime-and increases even further under EMU. Inflation, though, becomes more stable. EMU also induces a strong negative international transmission of country specific supply shocks and amplifies their role. This fact may complicate ECB policymaking. (C) 2002 Elsevier Science B.V. All rights reserved.