1. Is the European Monetary Union an Endogenous Currency Area
Is the European Monetary Union an Endogenous Currency Area? The example of the Labor Markets
Hubert Gabrisch, Halle Institute for Economic Research (IWH)
Herbert Buscher, Halle Institute for Economic Research (IWH)
Content
Unit Labor Costs and Trade Imbalances
The Theory of Endogenous Currency Area
A Model for Testing
Results
Other Research Approaches
Conclusions

2. The Theory of Endogenous Currency Areas
- Real theory vs. monetary theory (convergence vs. currency area approach; this paper is not about convergence, therefore, some critical remarks in the final section; this paper is related to the theory of OCA
The traditional version of the theory of OCA (Mundel I) dominated the debate on EMU in the 1980s and 1990s: `first establish the pre-requisites, than unify the currency‘ Krugman‘s specialization hypothesis (1993); currency areas can fail (Cheikbossian, 2001): the problem of different inflation tolerances The methodology: Bayoumi and Eichengreen (1993): ‚Shocking Aspects of European Monetary Integration.’ (business cycle correlation)
- The German experiences. But remember: crowning vs. endogenity in the German debate!
The theory of ECA: Frankel & Rose (1998): The basic idea is that conditions of OCA need not to be fulfilled ex-ante of a currency union, but they emerge ex-post
through single currency and common monetary policy.
Lucas critique (1976): a regime shift (in exchange rate regimes or, a currency union) will change the behavior of agents, and thus, the stability of coefficients in macroeconometric forecasting.

3. Unit Labor Costs and Trade Imbalances
Wage formation is a product of market processes and political intervention. This paper intends the testing of both!

4. What is new?
- The theory of ECA has been tested and applied to EU business cycle synchronization only:
- We apply the hypotheses of the theory of a endogenous currency area to the EMU labor markets and test them, using the standard empirical methods of the theory‘s empirical research program.
- We also control for the intervention of governments, in particularly, in their ability to use indirect taxes for replacing social taxes (part of labor costs)
- Standard approaches: analyse of bilateral correlation coefficients of labor cost developments, running a semi-structured model

5. The Model 3 sub-periods: 1981-89, 1990-97, 1998-2007
Bilateral correlation coefficients (logistic transformation) according to wage cost concept v and de-trending method s
Wage cost concepts: ULC, NCE, RCE; de-trending: growth rates, HP, AR(2)
Trade: bilateral trade intensity according to concept w: exports, imports, total trade: common currency enforces trade intensity (less transaction costs including exchange rate risks); hence, the presence of more foreign commodities of country i in country j strengthened the foreign sector in the domestic wage function. Theory predicts a ‚+‘
Finance: bilateral financial integration measured as relative difference between long- and short-run interest rates: common currency leads to more financial integration, hence, the balance of power changes to the detriment of labor. Theory predicts a ‚–‘.
Special: Bilateral sectoral specialization index: Krugman hypothesis: more specialization = less correlation (sector specific wage shocks. Theory predicts a ‚-‘.
TAX: controlling for political impact: relative share of indirect taxes in GDP: the higher the share the less wage cost developments are correlated: expect a ‚-‘!
3 sub-periods: , ,

6. Corelation coefficient analysis
See Tables 1-3 in the print-out (pp
Table 1: no clear picture, but evidence of declining number of significant cases
Table 2: This evidence strengthens with respect to highly significant coefficients
Table 3: We find a split between a Southern and a German (Northern) group: Intra-synchronization of wage formation is high in the Sourthern group, but broke down in the Northern group (above all in terms of NCE).

7. Regression results ULC 81-89 90-97 98-07 Constant Trade intensity
Export intensity
Import intensity
Total trade intensity
81-89
90-97
98-07
Constant --
-9.949
-0.274
-2.140
0.254
-8.912
0.411
Trade intensity
0.960
0.406*
0.057
0.108
0.756
0.188
Sector specialization
9.988*
1.201*
6.941*
0.702
0.437*
0.760*
Financial integration *
-0.380* *
-0.365* *
-0.346*
Indirect Tax ratio (TAX)
3.680*
-5.484*
3.382
-4.916*
3.801*
-5.169*
Adjusted R2
0.802
0.721
0.812
0.927
0.798
0.833
NCE
Exports
Imports
Total Trade
81-89
90-97
98-07
Konstante --
0.873
2.443*
-6.101*
0.342
-2.571*
1.983*
Trade intensity
-1.314
-0.111*
-2.943*
0.068
-2.643*
-0.058
Specialization
0.733
0.086
1.985*
0.839
0.781*
0.259
Finance
-4.543*
0.522*
-8.231*
0.453*
-6.292*
0.530*
Indirect Tax Rate
2.226
-7.371*
4.263*
-6.6.6*
1.997
-6.674*
Adjusted R2
0.762
0.998
0.892
0.900
0.836
0.930

8. Conclusions
We motivated our study with the ongoing debate on diverging labor costs and the role of national governments.
We found evidence for an emerging split between a Southern and a Northern group of euro countries with respect to labor cost developments.
We found only little evidence for the theory of ECA.
But, we found strong evidence of the impact of national tax policy.
We conclude that more co-ordination of tax and expenditure policies between euro members would help to avoid (i) divergences in nominal wage costs, and (b) divergences in inflation differentials.

9. Other approaches I: convergence
Fischer (2007), Deutsche Bundesbank (2007), Dullien & Fritsche (2007): long-run, equilibrium real exchange rate; ß-convergence, co-integration, error-correction model; related to growth theory: Open question: regime shifts might change the ‚convergence path‘ and intensity; the problem of short term deviations (Dullien & Fritsche).

10. Other approaches II: DeGrauwe (2006)
Euro area?
Symmetry C B
OCA-2 A
OCA-1
Flexibility of the labour market
What is wage coordination?

11. Other approaches III: micro
Third, our approach is different to the micro-economic view on the the impact of a common currency on labor markets. the impact of a common currency on wage formation and labor market institutions from a single-country perspective (Soscice and Inversen, 2000; Calmfors, 2001; Traxler, 2002; Holden 2003; Mongelli and Vega, 2006; Andersen and Seneca, 2008); open question: what is the optimal degree of labor market flexibility?
Hence, it is an approach to explain macroeconomic coordination/synchronization forced by the rigidities of a common currency via markets