Asymmetric Adjustment in Monetary Unions:Evidence from the Euro Area
Speech by Lorenzo Bini Smaghi, Member of the Executive Board of the ECBConference at the German Institute for International and Security AffairsThe Eurozone under stretch? Analysing regional divergences in EMU: Facts, Dangers and Cures Berlin, 19 June 2007
Ladies and Gentlemen, thank you for inviting me to this conference.
The good thing about academic conferences is that you can examine longer-term issues without necessarily having in mind the latest news and data. Indeed, when looking at the question in the title of this conference – “The Eurozone under stretch?” – the most recent developments might suggest that the topic is about the speed limit of the European economic recovery. The euro area has been blessed with good news recently, and if there is any stretch to it, it might be related to its growth potential over the medium term.
The rest of the conference title seems to refer instead to a somewhat gloomier economic scenario which might have prevailed until about 18 months ago. At that time, the continuation of relatively slow growth was considered a potential threat to economic cohesion in the euro area and issues related to asymmetries, divergences and differentials were indeed topical. While economic recovery has clearly alleviated some of those concerns, it is still unclear whether the current upturn is mainly of a cyclical nature, that would leave the structural problems of the European economy largely unsolved, or whether structural changes have taken place, which might also resolve some of the divergences we were interested in only a few months ago.
In fact, the reasons for this conference - analysing possible regional divergences and adjustment mechanisms in the euro area - do remain valid from an academic perspective. The question that I will consider is whether the economic and financial developments that we have observed since the launch of the euro differ significantly from those we expected at that time and from those of other monetary unions.
As you might remember, before the launch of the euro many experts and observers were concerned that a single monetary policy would not fit 11 diverse economies. Some even claimed it would fall apart not before long. The outcome so far might be disappointing for these “Cassandras”. The euro area is alive and well. It has expanded, with Greece joining in 2001, Slovenia in 2007 and (very probably) Cyprus and Malta next year. But this is no reason for complacency, however, as I will explain.
I will address five issues that were widely discussed in the run-up to the launch of the euro. What can we say today, with the benefit of hindsight, to shed some light on the worries – but also the hopes! – that many economists had?
The first two issues deal with the asymmetric transmission channels of monetary and fiscal policies, in particular with the possibility that in a monetary union these policies might be pro-cyclical. The third issue concerns the changes in competitiveness within the euro area, in particular the supposed lack of flexibility in real exchange rates once nominal exchanges rates became irrevocably fixed. The fourth issue concerns the relationship between EMU and the drive towards structural reforms. The fifth and final issue concerns the central role played by financial integration in the functioning of monetary unions.
Before I look at the five issues I would like to provide some clarification on the issues of convergence and heterogeneity in EMU.
There has been substantial analytical work examining whether economic developments across euro area countries have further converged or diverged since the introduction of the euro. Generally speaking, there is no evidence of an increase in cyclical divergence, quite the opposite in fact. The business cycle has been marked by growing synchronisation since the 1990s and remains high.  On the one hand, there is evidence of a stronger common euro area cycle that accounts for a large part of the business cycle fluctuations. Since 1999, the euro area has successfully weathered several shocks, including the bursting of the dotcom bubble, the ripple effect of 9/11, the surge in global commodity and energy prices, and the persistence of sizeable global imbalances. These shocks were considerable and the evidence is that they have spread in similar ways across euro area countries. They have not played an important role in output growth differentials and they have not contributed to divergences within the euro area.
However, there is still substantial and persistent heterogeneity across euro area countries. This heterogeneity stems from diverse sources, including:
a. idiosyncratic country-specific shocks;
b. different developments in total factor productivity (TFP), reflecting national differences and preferences in respect of innovation, industry characteristics and investments in R&D;
c. differences in discretionary fiscal policies; and, to a lesser degree,
d. differences in labour input, and in product and labour market institutions.
To some extent, part of the observed heterogeneity may also be due to the one-off shocks incurred by some countries immediately after the launch of the euro, including lower short-term and long-term interest rates as well as easier access to more competitive credit markets (which I will discuss next).
Structural differences still remain an important source of heterogeneity in growth and adjustment, but not only in the euro area.  They exist also in the US and at national level in Europe, particularly in large economies such as Germany, Italy and several others.  Compared with individual euro area countries, namely the former West Germany, Spain and Italy, the degree of dispersion of real GDP growth among euro area countries is consistent with historical patterns – although since 1999 it does seem that dispersion within the euro area has been higher than within these countries. But curiously, in some specific years, the degree of dispersion within individual countries was much higher than within the euro area, reaching levels of around four percentage points in Spain, for example. 
The issue of heterogeneity is rather complex and I must admit that I cannot tackle it here and now. Only a fully fledged analysis of each country’s economic and financial course prior to the launch of the euro would do proper justice to this subject. However, there is a general unit of measure, or gauge, of the effects of structural divergences, the most dramatic of which is the divergence in unit labour costs and, more generally, competitiveness. I will refer to it in the course of my speech.
Let me now turn to the five issues I would like to concentrate on.
The first issue: asymmetric transmission of monetary policy
This issue concerns the working of the real interest channel. It was extensively debated before the launch of EMU, under what was known at the time as the “Walter’s Critique”.  The argument runs as follows: since in a monetary union nominal interest rates are harmonised across countries, those enduring a higher inflation rate will bear relatively lower real interest rates. If the relatively higher inflation rate stems from an overheating of the domestic economy, then the associated lower real interest rate might have a pro-cyclical impact and foster a cyclical de-coupling from the rest of the union. A single monetary policy would be unable to tackle this asymmetry, since it can only target the average inflation rates for the whole monetary union, and could conceivably foster economic divergence within the union.
It is certainly difficult to measure the empirical effect of this asymmetry in the euro area. Furthermore, this factor should not be seen in isolation from the concurrent other developments taking place in the monetary union, in particular the changes in the relative competitive position, an issue I will examine later. The pro-cyclical effect arising from the common interest rate can be at least in part compensated by the anti-cyclical effect produced by the rigidity of the nominal exchange rate. While an asymmetric inflation shock tends to be accommodated by the common interest rate, it is instead counteracted by the loss of competitiveness with respect to the rest of the union.
Real interest rates have fallen across the whole euro area since the early 1990s and especially shortly before the launch of the euro, albeit at an uneven pace. The reduction was particularly relevant in Greece, Ireland, Italy, Portugal and Spain and also the Netherlands. In some of these countries lower interest rates have been accompanied by financial liberalisation, competition and easier access to credit markets by households and firms. This combination has provided a significant economic impulse in these countries. 
After the sharp decline in the run-up to EMU, real interest rates have been relatively stable. Hence, it appears that the main asymmetric aspect of the common monetary policy has been linked to the transition from previously higher inflation in some countries to a lower inflation regime, affecting the behaviour of economic agents and the functioning of domestic institutions and markets. This influence should fade over time.
There is also evidence that the monetary transmission mechanism has become more similar across countries since the launch of the euro.  Furthermore, there is a rising trend towards portfolio diversification that fosters cross-country risk sharing. These factors, together with the increased cyclical syncronisation of the economic cycle across countries that I just mentioned, tend to reduce the asymmetric effects of the single monetary policy.
The second issue: asymmetric fiscal policy
The argument is as follows: the 3 % deficit ceiling set by the Maastricht Treaty, which tends to be reached in cyclical downturns, is likely to push countries to adopt corrective measures in bad times and thus to implement pro-cyclical budgetary policies.
Let me first state that this is not a new problem, not even linked to monetary union. There is ample evidence that fiscal policy was pro-cyclical in several European countries for most of the 1970s and 1980s. Since the creation of the euro, the empirical evidence has been mixed. The run-up to EMU coincided with a tight fiscal stance, which lead to a pro-cyclical stance in bad times. Right after the introduction of the euro, fiscal policy was loosened as the economy recovered, thus leading to a continuation of a pro-cyclical behaviour also in good times. The worsening of budgetary balances in the following downturn led many countries into excessive deficits in the years 2003-05, requiring corrective actions in bad times; again a pro-cyclical stance.
Overall, there is no evidence that I am aware of suggesting that – as some feared at the time – pro-cyclicality increased with the introduction of the European fiscal framework In sufficiently large samples encompassing information over different time periods and across different countries, the relationship between the change in the cyclically-adjusted primary budget balance and the output gap seems to point to a pro-cyclical fiscal stance in good times and a broadly neutral stance in bad times. 
The reform of the Stability and Growth Pact, in 2005, was aimed at avoiding pro-cyclical policies, requiring strong adjustments in good times. The good times have now come, with 2006-07 recording higher than average growth. Indeed, for the euro area average, the cyclically adjusted deficit has improved form 2 percent in 2005 to 0.8 percent expected in 2007. The correction has been larger than 0.5 percent, as required. However, some adjustment fatigue seems to emerge over the next few years, as little improvement is projected in 2008 and further on. Furthermore, the situation is very diverse across countries. More worrying, the lessons of 1999-2000, when extra revenues arising from the better than expected cycle were used to increase expenditures or reduce taxes, rather than consolidate the budget, do not seem to have been fully learned. Discussions are emerging in several countries on ways to use the extra tax revenue obtained in the current recovery, thus putting at risk public finances when the economy will slow down again.
One could only imagine how much more pronounced would pro-cyclicality be without EMU and without the Stability and Growth Pact!
The third issue: competitiveness
One of the concerns expressed by economists before the launch of the monetary union was that fixation of nominal exchanges rates would unduly limit the flexibility of relative prices in response to idiosyncratic shocks. In fact, since the launch of the euro we have witnessed significant changes in real exchange rates. Can we conclude that real exchange rates have been flexible enough in the face of country-specific shocks? That is not easy to judge since changes in competitiveness can have various origins: some benign, reflecting a catching-up process, and others less benign. Let me provide you with some snapshots and then formulate some hypotheses.
a. Inflation dispersion among euro area countries has broadly stabilised at extremely low historical levels and has been on a par with that in the United States. However, euro area inflation differentials have been quite persistent, and this is a difference from the United States. In fact, inflation in most euro area countries displays significant inertia, with many countries exhibiting inflation rates above the euro area average for relativly long periods. There is a similar persistence in the low-inflation countries. Persistent differentials, which reflect structural rigidities in product and labour markets, are a concern.  Indeed, it takes time to adjust price and wage-setting behaviour to changing labour and product market conditions. To the extent that movements in nominal exchange rates are no longer available to absorb country-specific inflation differentials, the impact of such shocks on competitiveness may have been magnified under EMU. This calls for structural policies to increase the flexibility of price and wage-setting behaviour in order to bring it in line with the new reality represented by monetary union. To some extent, as I will argue later, we are already moving in that direction.
Looking at unit labour cost developments more closely, the evidence suggests that differentials were mainly due to divergencies in compensation per employee than to changes in labour productivity. However, in a few cases the two components appeared to be equally important. For example, low labour productivity seems to be responsible for the observed differential in unit labour cost growth between Italy and the rest of the euro area. Perhaps we are now seeing signs of limited reversals of this trend, with some euro area countries with relatively high inflation rates having moved down to, or even below, the euro area average, but these corrections appear to be quite slow to materialise.
b. Protracted changes in relative unit labour costs and inflation differentials have led to some significant changes in cost and price competitiveness.  In fact, more changes in competitiveness have occurred than perhaps was anticipated before the launch of the euro. According to recent figures, the difference in the cumulated growth of unit labour costs for the total economy between the “highest increase” and “lowest increase” countries was between 20% and 25% during the period 1999-2005.
Let me emphasise that not all changes in competitiveness are of the same nature. To the extent that unit labour costs increase at a relatively faster pace in euro area economies with lower initial level of per capita GDP, this might be the reflection of a Balassa-Samuelson effect. It may be part of a catching- up to higher living standards, and might be justified to the extent that it reflects convergence towards a new equilibrium.
Another situation is that of countries that have adopted the euro with an exchange rate above their historical levels, which have been able to bring their real exchange rate back to sustainable levels through persistently lower than average cost inflation. This was notably the case for Germany, which posted very low inflation and moderate growth in unit labour costs over the last 10 years, thus recuperating the lost competitiveness.  A totally opposite case is that of the Netherlands, which adopted the euro with a relatively high level of competitiveness, an advantage which was rapidly lost as a result of the cumulative increase in nominal unit labour costs between 1998 and 2003. Competitiveness was restored from 2003 onwards only through significant wage restraint and fiscal consolidation, which led to a dampening of domestic demand. Some other euro area countries have instead displayed a combination of weak labour productivity growth and strong increases in nominal wages and salaries for a sustained period. This has pushed their unit labour costs up, to levels persistently higher than the euro area average, hampering growth and job creation. Italy is often mentioned as an example.
To sum up, during these eight years, the euro area has experienced both good and bad changes in competitiveness. The good changes have taken time and have been accompanied by painful adjustments in growth and employment. The bad changes, which are not in line with underlying fundamentals, have been quicker to occur and to accumulate. They suggests that in several member countries the mechanism for determinig wage development are not optimal in a monetary union. In Italy, Spain, Greece and - to a lesser extent - France, where wage growth has not been consistent with productivity, competitiveness has deteriorated significantly. To regain the lost competitiveness, these countries will have to undertake a similarly painful adjustment to the one conducted in Germany over the last years.
In all these countries, the challenge remains to adapt their wage and price-setting behaviour and their product and labour market institutions to reflect the new reality of the monetary union.
The fourth issue: does the euro encourage or hinder structural reforms?
Before the launch of the euro there were opposing views on whether the euro (i.e., the single currency and its governance) would encourage or hinder structural reforms. One pessimistic view was that monetary union would undermine the incentives to reform as the loss of monetary policy discretion at national level would discourage the implementation of large-scale reform, due to the lack of macroeconomic stimulus that can facilitate them.  A more optimistic view was that product market deregulation and enhanced competition would reduce rent-seeking positions, and the incentives to appropriate such rents would decrease, reducing insider power and leading to labour market deregulation.  Yet another cautious view was that EMU would increase the likelihood of gradual reforms and the coordination of reforms among across countries.
The empirical evidence is that the functioning of the euro area labour markets started to improve in the late 1990s. The fall in the unemployment rate and the increase in participation were accompanied by a decline in the NAIRU, thereby suggesting structural improvements. Structural reforms have gained momentum recently, and we have seen the results in Germany, Italy and other euro area countries.  The interesting question is whether the membership in the euro area has made these reforms more likely than would otherwise have been the case. It is obviously a very difficult question, maybe impossible to answer, in particular because we do not have counterfactual evidence. The three EU-15 countries that do not participate in the euro area have a substantially different situation that does not allow a meaningful comparison.
In my view, the euro has increased the level of transparency and comparability across euro area countries, making it easier, for citizens, political academics, to understand why performances differ. It is now well understood that these differences are related to differences in economic structures. Therefore, in EMU, it has become easier to understand that in order for a country to improve its economic performance and make it comparable to others, it has to implement reforms. This doesn’t make reforms easy to implement, but it is clear that other instruments such as monetary or exchange rate policies are simply not available. In a flexible or adjustable exchange rate regime it might have been more tempting, and politically less costly, to tackle structural issues through short-term monetary measures, rather than through far reaching reforms.
Seven years after the launch of the Lisbon Strategy, Member States have confirmed their commitment to continue to deliver effective structural reform measures. As emerged from last autumn’s progress report on the National Reform Programmes, measures have been adopted in the areas of regulation, tax and benefit systems, innovation and competition. While most governments have to date fallen short of their commitments under the Lisbon Agenda, it is fair to say that at least the governance of the Lisbon Strategy has improved since the 2005 mid-term review.
Although the prevailing mood seems to be one of cautious optimism, it should not be allowed to turn into complacency. Much more still needs to be achieved. The types of structural reform that have taken place in labour and product markets in recent years have not always been those that enhance best the process of adjustment. They have been often at the margin, leading sometimes to a dual labour market, with permanent and still highly protected jobs on the one hand, and fixed-term and unstable jobs on the other. There is also some evidence of a slowdown in the pace of reform especially in the larger euro area countries. ,  The risk that I see in several countries, including Germany, is that the current strong recovery induces a relaxation of the reform effort. This will ultimately lead to the emergence of bottlenecks in various markets and hamper a strengthening of growth potential. Speed limits on growth will hit potentially sooner than expected, thereby unleashing inflationary pressures. If the reform process stops, monetary policy might need to act more decisively to safeguard price stability over the medium term.
To governments and social partners that express concern about the risks of possible further tightening of monetary policy, I would answer that the best recipe against such a risk is to continue with reforms that strengthen growth potential and alleviate inflationary pressures.
To sum up, there have been more reforms than are usually assumed. However, the types of reform matter – and more reforms to enhance flexibility are needed in several countries, not only to make the euro area work better, but to keep up with the challenges of globalisation.
The fifth issue: the central role played by financial integration
My final issue is about the central role played by financial integration in the functioning of monetary union. The run-up to EMU saw a clash between two different schools of thought on the effects of financial integration. One school believed that financial integration would foster an improved allocation of capital, higher efficiency, and higher economic growth. Financial markets can provide a significant source of insurance against asymmetric shocks.  To the extent that monetary unification enhances financial integration, it will endogenously improve insurance against asymmetric shocks, thereby reducing the costs of forsaking direct control over the exchange rate. According to Asdrubali et al. (1996),  US capital markets smooth out 39% of the shocks to gross state product (which is the equivalent to our GDP), the credit channel smooths out 23% of such shocks, and the federal government only 13%. 25% of such shocks are not smoothed out at all. Hence, in the United States, financial markets and financial institutions account for 62% of the absorption of state idiosyncratic shocks, far higher than the cushioning provided by the federal budget. 
According to the other school, higher financial integration makes specialisation in production more attractive, rendering macroeconomic fluctuations less symmetric. The specialisation paradigm – à la Krugman – postulates that as countries become more integrated they also become increasingly specialised. The dynamics underlying this process are based on economies of scale and agglomeration effects, and may lead to more asymmetric macroeconomic fluctuations in the monetary union. In a nutshell, EMU would become over time less of an optimum currency area. 
What is the evidence so far? Since the launch of the euro, financial markets in Europe have certainly become more integrated, although the degree varies widely across market segments.  The impact of the euro on financial markets is evident in some segments such as money markets. In other segments, the introduction of the euro may just be starting to contribute to greater depth and liquidity. In bond and equity markets a gradual process of structural change and increasing integration is unfolding. Evidence of significant risk-sharing is modest so far, but encouraging. However, there are several areas in which financial market integration has not yet had significant effects. I will list some of the initiatives aimed at promoting further financial integration. Together with the Eurosystem, the ECB is playing a very active role also in fostering a single market in financial services. Let me mention a few. First, the launch of TARGET2 – the new payment platform for the financial system – is planned for the end of 2007. Second, we are participating in the Short-Term European Paper (STEP) initiative to promote the convergence of better market standards and practices in the European short-term securities markets. Third, we contributed to the European Commission’s Green Paper on Mortgage Credit in the EU at the end of 2005. This is an important segment of the banking and retail markets, with an outstanding volume of residential mortgage debt in the EU. Fourth, the project for a Single Euro Payments Area (SEPA) under which all banking transactions in the euro area will incur the same charges as a domestic transaction. This will be a powerful engine for the further integration of financial markets. Finally, we have recently launched a new initiative – TARGET2-Securities, which will lead cross border transaction costs in the security market to align to domestic costs.
In light of my earlier remarks, I would tend to reject the hypothesis that financial integration is fostering economic divergence and would argue that it actually helps to reduce the impact of idiosyncratic shocks. Over time, greater financial integration and modernisation will make it easier for European households to insure against idiosyncratic risks, by borrowing and lending and cross-country ownership of financial assets, which will allow for more income-smoothing.
Looking forward: final remarks
I’d like to make some final remarks. Quite a lot has already happened since the introduction of the euro. There have been some important achievements and most of the asymmetric effects we have seen so far have been benign.  There is evidence that the euro may be setting in motion some endogenous process, moving the euro area progressively closer to the concept of an optimum currency area.  It has boosted intra-euro area trade by 5% to 10%. There has been no trade diversion vis-à-vis the rest of the world: i.e., no “fortress Europe”.  Further trade effects arising from EMU may take longer to materialise. 
The euro is having remarkable effects as a catalyst for a single market in financial services, particularly in the market segments that are more directly affected by the single monetary policy, such as fixed income markets. Euro area equity markets are rapidly becoming more integrated. Stock prices in euro area countries are being increasingly affected by euro area-wide factors and news. By contrast, the pace of integration in retail banking has been relatively slow to date, although it has picked up in the last two years. As I just mentioned, the ECB is playing a very active role in fostering the completion of a single market for financial services.  The euro has already established itself as an important world currency and generated significant benefits for euro area countries.
Despite these achievements, a lot more needs to be done. In some euro area countries, price and wage-setting behaviour have not yet completely adjusted to an environment of very low inflation as the one we are living in. Such delays are having a visible impact on the level of competitiveness of some countries. The longer it will take to get back on track, the more costly the adjustment process will be.
To be sure, the EMU project has fuelled an intense and fascinating debate on the adjustment mechanism and the degree of optimality of currency unions. The realisation of the euro allows us to test some of the theories and hypotheses. We are starting to get some answers, although it might still be a bit too early to reach definitive conclusions. My personal feeling is that many of the forces inherent in a monetary union are still in the process of being unleashed and we will see their full impact only in several years. Monetary union is indeed a “change in regime”, in the Lucas’ sense, that involves many dimensions – behavioural, institutional, political – so that at this stage any analysis, any result, can only be considered as partial. But this makes the subject even more fascinating, not only for academics but also for policy makers which have a responsibility for shaping the process.
Thank you very much for your attention.
 The author would like to thank Francesco Paolo Mongelli for his input in the preparation of this speech. Livio Stracca, Juan Luis Diaz del Hoyo, Annalisa Ferrando, Manfred Kremer, Roberta Serafini, Luca Onorante, Matthias Mohr, Ana Lamo, Hedwig Ongena, and Stefan Humer provided useful comments and suggestions. The opinions expressed in this speech are those of the author and not of the institution he represents.
 See Giannone D. and L. Reichlin (2006) “ Trends and cycles in the euro area: how much heterogeneity and should we worry about it?”, ECB Working Paper No 595.
 See the article entitled “ Output growth differentials in the euro area: sources and implications” in the April 2007 issue of the ECB Monthly Bulletin.
 See Obstfeld, M., and Giovanni Peri (1998) “Regional Non-Adjustment and Fiscal Policy,” Economic Policy, Vol. 26 pp. 205-260, and S. Kalemli-Ozcan, B. Sorensen and O. Yosha (2004) “ Asymmetric shocks and risk sharing in a monetary union: Updated evidence and policy implications for Europe”, CEPR Discussion Paper No 4463. Bent Sorensen is currently completing a project ascertaining this finding for both Germany and Italy.
 See N. Benalal, J. L. Diaz del Hoyo, B. Pierluigi and N. Vidalis (2006) “Output growth differentials across the euro area countries: some stylised facts”, ECB Occasional Paper No 45.
 See, among others, Allsop C. and D. Vines (1998) “The Assessment: Macroeconomic Policy after EMU”. Oxford Review of Economic Policy, Vol. 14, No 3.
 See European Commission (2006) “ The EU Economy 2006 Review: Adjustment Dynamics in the Euro area Experiences and Challenges” for an extensive discussion of adjustment mechanisms.
 Angeloni I., A. Kashyap an B. Mojon (2003) Eds, Monetary Transmission in the Euro Area, Cambridge University Press.
 See European Commission (2006) “Public Finances in EMU 2006”; Part IV; in particular the table on the empirical literature p. 177.
 See ECB (2005), “Monetary policy and inflation differentials in a heterogeneous currency area”, Monthly Bulletin Article, May 2005.
 In order to contribute to this monitoring, the ECB has recently started to publish some Harmonised Competitiveness Indicators (HCIs). See Box 6 in the February 2007 ECB Monthly Bulletin. Over the period 1999 to 2006, most euro area countries recorded an increase in the HCIs, indicating an overall deterioration in price competitiveness for the euro area. However, the changes in competitiveness differed substantially across countries, pointing to a change in relative competitiveness. Austria, Finland and Germany experienced a moderate decline in their HCIs, indicating an improvement in their price competitiveness, whereas, at the other end, rises in the HCIs were particularly strong in Ireland and Spain.
 See also Trichet J.-C. (2006) “The Process of Economic, Monetary and Financial Integration in Europe”, Jean Monnet Memorial Lecture, European Business School at: http://www.ecb.europa.eu/press/key/date/2006/html/sp061129.en.html
 See, among others, Soskice D, T, Iversen, and J. Pontusson (2000) (eds.) “Unions, employers, and central banks: macroeconomic coordination and institutional change in social market economies, Cambridge University Press, and L. Calmfors (2001) “Unemployment, Labour Market Reform, and Monetary Union”, Journal of Labour Economics, Vol 19.
 See, Blanchard, O and F Giavazzi, (2003) “Macroeconomic Effects of Regulation and Deregulation in Goods and Labor Markets,” Quarterly Journal of Economics, August, 118(3), pp. 879-907.
 See Duval and Elmeskov (2006) “The Effects of EMU on Structural Reforms in Labour and Product Markets,” ECB Working Paper series No 557.
 See again Duval and Elmeskov (2006) “The Effects of EMU on Structural Reforms in Labour and Product Markets,” ECB Working Paper series No 557. The argument goes as follows: Duval and Elmeskov observe that on average, the intensity of structural reforms over 1994-2004 has been greater in the euro area than in the rest of the OECD, with top reforming countries being small EMU countries. Reforms have also been typically deeper while at the same time more comprehensive in the euro area. However, reform intensity has not been greater in EMU than in non-EMU EU countries. Furthermore, the advent of EMU did not coincide with an acceleration of reforms: reform intensity was lower from 1999 to 2004 than from 1994 to 1998. No such slowdown was observed in non-EMU EU countries. There is also an asymmetry: larger euro area countries have thus far been slower than others in securing structural reforms: this is restricting their adjustment mechanisms, hindering their ability to cope with economic events and reducing the net benefits from EMU for all – more interlinked – euro area countries.
 Boeri, T. (2005), "Reforming labour and product markets: Some lessons from two decades of experiments in Europe", IMF Working Paper, No. 05/97, May and Boeri, T., G. Bertola and G. Niccoleti (2001) eds., Welfare and Employment in a United Europe, Cambridge MA: MIT Press, pp. 1-20.
 See Mundell, Robert A. (1973) “Uncommon Arguments for Common Currencies”, in H.G. Johnson and A.K. Swoboda, The Economics of Common Currencies, Allen and Unwin, pp.114-32. This paper is often referred as the Mundell (II) paper.
 See P. Asdrubali, B. Sorensen and O. Yosha (1996), “ Challenge of interstate risk sharing: United States 1963-1990”, Quarterly Journal of Economics Vol. 111.
 According to some, this finding puts into perspective the absence of a European “federal budget” – akin to the US Federal Budget – capable of absorbing part of the idiosyncratic country-specific shocks. It also shows the critical importance of financial-based adjustment, thus highlighting an additional reason for the ECB to speed up financial integration.
 Krugman, P. (1993), “Lessons of Massachusetts for EMU” in Francisco Torres, and Francesco Giavazzi (eds.) Adjustment and Growth in the European Monetary Union, pp. 241-269.
 See ECB (2007) “Financial Integration in Europe” report that can be downloaded from: http://www.ecb.europa.eu/pub/pdf/other/financialintegrationineurope200703en.pdf; and Cappiello, Hördahl, Kadareja, and Manganelli (2006) “The impact of the euro on financial markets,” ECB Working Paper series No 556, and Baele, L., A. Ferrando, P. Hördahl, E. Krylova and C. Monnet (2004), “Measuring financial integration in the euro area”, ECB Occasional Paper No 14.
 See, for example, European Commission (2006), “ The EU Economy 2006 Review: Adjustment Dynamics in the Euro area Experiences and Challenges, for an extensive discussion of adjustment mechanisms”, and Mongelli F.P. and J. L. Vega (2006), “ What effects is EMU having on the euro area and its member countries? An overview”, ECB Working Paper No 599.
 See De Grauwe Paul and Francesco Paolo Mongelli (2005) “Endogeneities of optimum currency areas: What brings countries sharing a single currency closer together?” ECB Working Paper No 468.
 See Baldwin (2006) “The euro’s trade effects,” ECB Working Paper Series. ECB WP No 554, and Anderton, di Mauro, and Moneta (2004) “Understanding the impact of the external dimension of the euro area: trade, capital flows and other macroeconomic linkages,” ECB Occasional paper no. 12. Jeffrey Frankel and Andi Rose have often argued that it will take about 30 years for the full effects of the euro to display its effects on trade.
 In any case, given that trade among European countries has continuously risen over the last 50 years, it may be difficult to witness further spectacular surges in intra-European trade. See Mongelli, F.P., E. Dorrucci, and I. Agur (2005) “What does European Institutional Integration tell us about economic and financial integration?” ECB Occasional Paper No 40.
 See ECB (2006), “ Competition, Productivity and prices in the euro area Services Sector”, Task Force of the Monetary Policy Committee of the European System of Central Banks, Occasional Paper No. 44.
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