The sustainability of European Monetary Union. Evidence from business cycle synchronisation, monetary policy effectiveness and the Euro fiscal dividend.

Abstract

EMU as the only functioning single currency area has been criticised as a non-optimal currency area since the Treaty on European Union was signed. Despite this, it has been seen as, probably, the most complete economic project that has ever been conducted by any group of governments. Through Dynamic Factor model and Panel VAR method, we are focusing on the issues of business cycle synchronisation, effectiveness of ECB monetary policy and the euro fiscal dividend, thus to advances the current studies on EMU through assessing whether it can be a sustainable system. For example, whether economic fluctuations can be effectively managed by implementing a single ECB monetary policy and financial market can be relied upon as a monitoring and enforcing device to discipline fiscal behaviour of Eurozone countries. Overall, we concluded that EMU could be more sustainable if it was just formed by its core members, leaving the periphery outside the single currency area. However, since the EU has recently conducted many rescue measures to save the Eurozone, we are unlikely to see those troubled countries to quit EMU, at least, at the present time. The sustainability of the current EMU can be improved if more intra-trade can be promoted to enhance business cycle convergence; hence, it will be more likely to have a union-wide appropriate monetary policy. This will also reduce the requirement of depending upon using fiscal measures to compensate the loss of monetary sovereignty. Moreover, fiscal activities can also be better monitored/enforced since the financial market has begun to adequately adjust the long-term interest rates on Eurozone government bonds according to the development in those countries fiscal stance.