Better in or out? Assessing the impact of the European Monetary Union on cross-country price convergence, foreign direct investment, and foreign portfolio investment

On January 1st 1999, eleven countries formed the European Monetary Union, adopting a common currency and coordinating all monetary policy through a single entity, the European Central Bank. This was a significant event not only for the member countries, but also for those countries that chose to remain apart. The membership prospects for both EMU and non-EMU states are tied to the benefits and costs of the EMU, which can be traced back to the optimum currency area studies of Mundell and McKinnon. The overriding goal of this dissertation is to examine some of the potential benefits of the EMU, particularly those that have not received as much attention in the existing literature as trade effects or the loss of independent monetary policy. This dissertation explores the effects of a common currency on relative price convergence, foreign direct investment, and foreign portfolio investment. Cross-border price volatility has fallen within the union, although these effects vary by country size. Membership through a monetary union attracts FDI through greater export market access. This gain comes at the expense of non-members, with the UK estimated to have lost over {dollar}30 billion in FDI from the US alone between 1998 and 2002. Finally, membership in a monetary union tends to increase cross-border portfolio diversification, mainly by reducing information asymmetries across the union. While these results alone are not enough to justify membership in the EMU, they provide meaningful evidence in the debate over its merits.