| The purpose of the dissertation is to investigate whether or not a common currency is the best exchange rate regime for Europe, given the fact that different labor market structures exist among European countries. Our analysis is based on a two-country model, in which one country has a perfectly competitive labor market, while the other has a wage-contracting labor market. To examine the implications of European Monetary Union (EMU), we incorporate labor immobility and asymmetric shocks (country-specific shocks) into our model. We assume that the two countries are highly interdependent, in the sense that a change in one country's economy has strong spillover effects on the other. Furthermore, the monetary authority conducts policy with a rule under the assumption that economic disturbances cannot be observed ex ante. To determine the best exchange rate regime for each country for minimization of the losses with respect to output and consumer price index (CPI) inflation, we derive and compare results under four exchange rate regimes: a common currency, a float, and two cases under a fixed exchange rate. Results of this work are summarized as follows. First, a common currency is not the best exchange rate regime, in minimizing the losses due to output and inflation, for both the classical and wage-contracting country. Second, if countries are highly interdependent, a fixed exchange rate is more desirable than a float for stabilizing the economy against the losses due to output or inflation. Third, the economy of the classical country (with a competitive labor market) is affected by that of the wage-contracting country (with a noncompetitive labor market). Fourth, the optimal exchange rate regime for each country depends on the predominant shocks in the economy. In general, a common currency is neither the best nor the worst exchange rate regime for the two countries. Thus a common currency is a second-best compromise for European countries with different labor market structures. From this perspective, EMU may be warranted. |
