DP517 | Adjustment Difficulties within a European Monetary Union: Can They be Reduced?

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This paper analyses four costs which may be associated with monetary union. First it (obviously) allows no `relative' monetary accommodation of the kind which may assist when dealing with asymmetric shocks. This can impose significant adjustment costs. Second it does not of itself prevent `absolute' accommodation to an inflation shock originating in all members, or even one member, of the union. Third, the distribution of benefits of membership of the union may be skewed. Finally, a union may require significant fiscal flexibility to mitigate against the adjustment costs. We investigate the form of fiscal flexibility which may be required, and we also propose a form of Soft Monetary Union which might alleviate the first problem.