The Unites States as a Source of Shock Asymmetry in the Euro Area

Ten years into the establishment of the Euro Area, questions still exist as to whether the members of the EMU form an optimal currency area (OCA). One particularly important criterion of an OCA that is still in question is whether shocks are sufficiently symmetric across member states.  Shock symmetry is important because members of a monetary union lose the ability to conduct independent monetary policy. When shocks are sufficiently different across members, the currency union’s monetary authority is unable to address the individual needs of its member states. They may even contribute to or magnify a country’s macroeconomic fluctuations, leading to discontent and increased uncertainty in the currency union.   

Studies of shock asymmetry in the Euro Area typically find a “core”, where shocks are more symmetric, and a “periphery”, where shocks are more asymmetric (Crowley, 2005). The reasons for this difference have yet to be fully explored. In this paper we investigate whether the United States plays a role in shock symmetry across the Euro Area. Favero and Giavazzi (2008) suggest that US variables have an important impact on European variables as a whole and that they are more important than local variables in the policy rule followed by the European Central Bank (ECB). US monetary policy (Neri and Nobili, 2006) and liquidity (Berger and Harjes, 2009) have also been found to effect macroeconomic variables and policy in the Euro Area. Schneider and Fenz (2008) find that even though domestic shocks explain the largest share of macroeconomic fluctuations there are some spillover effects that are important in the medium run between the US and Europe.

In each of these studies, the authors looked at how US variables have influenced the Euro Area as a whole. We test whether US macroeconomic fluctuations and policy effect individual Euro Area countries differently and thus become a source of possible asymmetry. We use a structural VAR with contemporaneous restrictions to identify US macroeconomic and policy shocks. Quarterly measures of output, prices, and interest rates from the US and each EMU country are used.  We then construct impulse response functions that represent how each EMU country responds to these shocks. Preliminary results suggest a core and periphery exists in the way the EMU members respond to US macroeconomic fluctuations. Because US shocks do not uniformly affect European members, they are a possible contributing factor to shock symmetry among the core and shock asymmetry in the periphery; thus further complicating monetary policy for the ECB.