Should All of Europe Share a Currency? A Multi-country Analysis

Does the utilization of a common currency increase welfare in the European Union? This paper will review economic literature related to Optimum Currency Areas (OCA’s) in an attempt to answer this question. Macroeconomic data from several countries will be compared and contrasted in order to highlight symmetrical demand shocks, and the degree to which markets are integrated in these countries. These comparisons are important because, as we will see, economic theory on the topic of optimum currency areas dictates that countries should have symmetrical demand shocks and should have highly integrated markets if a currency area between those countries is to be optimum (Mckinnon, 1963; Mundell, 1961; Feenstra and Taylor, 2008). Further, it will be argued that the European Union has not succeeded in becoming an OCA. The reason for this is that countries within the European Monetary Union do not meet the criteria for an OCA because (1) asymmetric demand shocks occur within the European Monetary Union (EMU) (Buti, 2008; Feenstra and Taylor, 2008), and (2) labor and capital markets are not integrated to an extent necessary for an OCA. Also, we will see that periods of somewhat symmetrical demand shocks and elevated market integration can be explained by increased government expenditures in some countries. For example, the increased government expenditures in Greece led, in part, to the recent fiscal crisis in Europe. Furthermore, this dilemma is not unique to Greece. Periods evidencing market integration and symmetric demand shocks can be partially explained by elevated government spending in many countries in the European Union. Therefore, although “austerity packages” may lead to reduced government debt and deficits, they will also lead to market disintegration and asymmetric demand shocks. 3 This finding underscores the current dilemma facing the EMU. While austerity packages may be necessary to cut government deficits in countries such as Greece, Spain, Turkey, Ireland, and Portugal, government spending in these countries has accommodated symmetrical demand shocks and market integration in EMU countries.

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