Scandinavian Working Papers in Economics

Working Paper Series,
Uppsala University, Department of Economics

No 2003:29: Booms and Busts in EMU

Nils Gottfries ()
Additional contact information
Nils Gottfries: Department of Economics, Postal: Uppsala University, P.O. Box 513, SE-751 20 Uppsala, Sweden

Abstract: A floating exchange rate combined with a clear inflation target can be a powerful stabilizer even if there are fluctuations in exchange rates that are unrelated to current fundamentals. Under plausible conditions, most of the stabilisation will occur through the exchange rate, and fundamental shocks will generate considerable medium term exchange rate volatility. The consequences of asymmetric shocks inside EMU are worse than envisaged in early analyses of the EMU project such as Calmfors et al. (1997). Inflation and real interest rate differentials arise which magnify the imbalances and cause boom-bust cycles in the member countries.

Keywords: optimal currency area; imperfect competition; interest parity; real interest rate

JEL-codes: E31; E32; E42; F41

35 pages, December 9, 2003

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