EMU, Monetary Policy Interactions and Exchange Rate Stability

This memorandum discusses the possible impact of a monetary union in Europe on transatlantic exchange rate stability. EMU leads to the elimination of coordination failures within the euro area. Whether this translates into more stable exchange rates, depends on the origin of the shock. Martin?s (1997) conclusion that EMU will lead to more stable exchange rates is shown to hold for both symmetric and asymmetric shocks in Europe, but not for shocks that originate out-side Europe. The results remain valid when taking into account that the pre-EMU era was characterised by a Bundesbank-led ERM, rather than a free float. Finally, the results are tested for a future expansion of the euro area.