Publications and Research

The objective of this paper is to provide an empirical evaluation of the degree of shock asymmetry between eight European countries that would form the core of a monetary union. Given that the relevant measure is the degree of real shock asymmetry, our approach is to use the observed movement in real exchange rates as an indicator of the degree of shock asymmetry and to decompose it into real (permanent) and nominal (temporary) components, using information from the nominal exchange rate in a bivariate system. The decomposition method used is similar to that proposed by Blanchard and Quah (1989) and has been adapted to the case of exchange rates. In general, the results indicate that even in the short run, real shocks represent the dominant source of fluctuations in real exchange rates. The results also suggest that Germany, the Netherlands and Belgium together could form the core of a monetary union, whereas Spain and the United Kingdom could potentially face serious adjustment costs. The other countries included in the study (France, Italy and Switzerland) represent intermediate cases.