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The efficiency gains stemming from the single currency in terms of lowering transaction costs and deepening the internal market are large. But for individual member countries the loss of monetary policy instruments carries a potential cost in terms of larger swings in economic activity, depending on the degree to which business cycles and the shocks that shape them still differ. In the absence of monetary policy instruments, and with the leeway for fiscal policy also limited, adjustment will have to rely on changes in external competitiveness operating through wages and prices. In the first five years of the euro area’s existence, economic performance across the individual economies has differed considerably, with activity in Germany and Italy subdued, but strong in some smaller countries. Equilibrating forces coming through external competitiveness have been at work to some extent, but not uniformly so; where they were at work, the competitiveness gains were in some cases too small to pull the economy out of stagnation. Moreover, as inflation differentials between some of the more dynamic and the more sluggish economies widened, real interest rates reinforced cyclical differences, with soaring house prices in the dynamic economies producing wealth effects on consumption. Since country specific shocks (and country specific responses to global shocks) will remain a feature of the euro area, swift inter country adjustment is crucial for the area’s resilience - not least because it would allow a more effective monetary policy response.
A number of priorities for policy in the pursuit of more rapid inter country adjustment emerge:
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The effectiveness of the competitiveness channel should be enhanced. In particular the integration of services sectors should be stepped up to raise intra area competition so as to reduce price inertia.
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Wage flexibility should be raised. Nominal wage rigidities, which may become more prevalent in a low inflation environment, must be tackled to shorten the adjustment period after an adverse shock.
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Cross country differences in housing market institutions are striking. Policies in the pursuit of well functioning housing markets, while aiming to avoid excessive price volatility may help to smooth the cycle and stem country specific shocks.
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The social security and tax systems that underpin the automatic fiscal stabilisers should be designed so as to ensure that the incentives to which they give rise strengthen the flexibility of labour and product markets.
Inflation and output dispersion
1. Harmonised index of consumer prices.
2. CPI All Urban Consumers for 27 areas.
3. Average for 1999-2003.
4. Per cent of potential GDP.
Source: OECD; US Bureau of Labour Statistics.
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The full edition of the OECD Economic Survey for the Euro area is available from:
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SourceOECD for subscribing institutions and many libraries
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Government officials with OLISnet accounts
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Return to the OECD Economic Survey - Euro area 2004 homepage
A printer-friendly Policy Brief (pdf format) may also be downloaded. The Policy Brief contains the OECD assessment and recommendations, but does not include all of the charts available from the above pages
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