OCA theory and EMU Eastern enlargement – An empirical application

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The accession of several Central and Eastern European Countries to Euroland is likely to be realised within the next years and it is an important issue to assess whether these candidates are prepared for EMU membership better or worse than the current participants.

The theory of optimum currency areas (OCA) provides several criteria and econometric tools for analysing a prospective monetary union. Building on these considerations, some studies aim at assessing the suitability of the Eastern Euro aspirants for currency union with EMU by evaluating the related macroeconomic costs. Still, they are prone to the Lucas critique since they do not consider endogeneity of the relevant criteria.

This paper employs methodologies developed with regard to the theory of optimum currency areas in the context of present EMU and uses a structural VAR approach to identify economic shocks that hit the Euro aspirants in the past. Correlations of these shocks with those of current EMU countries do shed light on the question whether a common monetary policy may be suitable or not.

To correct for the widespread flaw of previous studies we use lagged time series for the reference area in order to account for endogeneities. An evaluation of the changing country characteristics within the process of integration in Western Europe confirms the importance of this approach.

Read the

full studyon the Deutsche Bank Research website.  

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