Evidence suggests that after a period of convergence in the early and mid-1990s, the euro area economies may have started diverging. As a consequence, the common monetary policy could become well-suited for a number of countries. This paper studies the extent and severity of the recent divergences, and discusses the capacity of exposed countries to compensate for nationally suboptimal monetary conditions through other policy channels. As a step toward developing an analytical framework for monitoring intra-euro area developments, we present a “convergence barometer” to monitor divergences, and a Taylor rule based “monetary thermometer” to compare the common monetary policy to benchmark optimal policy for individual countries. A main conclusion is that policymakers at the euro area level should be concerned about divergences, since automatic stabilisers alone may not be enough to restore a healthy equilibrium to potential “outlier” countries.
Introduction: Differences in economic developments in euro area countries are making area-wide statistics difficult to interpret. In recent months, attention has focused on the divergence of business cycles between the euro core and periphery, and now even within the core. The implications of these developments are still unclear. With rapid and wide-ranging structural changes taking place, even country-specific statistics have become misleading. At the same time, there is an alarming knowledge gap regarding developments at disaggregated levels, given the difficult and ongoing process of harmonisation of statistics in Europe. Individual governments should be concerned, as the automatic adjustment mechanisms of labour and product markets are clearly being tested earlier and more severely than had initially been anticipated. Should the European Central Bank (ECB) also be concerned? Monetary policy can no longer address imbalances that emerge within the euro area. Why, then, is it important for monetary authorities to monitor internal divergences? There are two important reasons. First, the presence of diverging internal trends can complicate decision-making. In order to prescribe an appropriate mix of policy measures, such weighted averages which underlie policy decisions could usefully be supplemented with more disaggregated statistics.
Author: Nils Björkstén, Miika Syrjänen
Source: Research Discussion Papers, Bank of Finland
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