Will a Common European Monetary Policy Have Asymmetric Effects?
Guiso, Luigi, Kashyap, Anil K., Panetta, Fabio, Terlizzese, Daniele, Economic Perspectives
Introduction and summary
The launch of the euro has been accompanied by a vigorous debate. On the one hand, supporters of a common monetary policy (for example, Lamfalussy, 1997) have argued that the move to a single currency is necessary to fully exploit the obvious advantages of a single market. On the other hand, skeptics have argued that European Union (EU) economies are too dissimilar to be subjected to a common monetary policy. Feldstein (1997) goes so far as to predict that the political tensions created by the common monetary policy could lead to another European war.
The debate boils down to a disagreement over how hard it will be to effectively run a common monetary policy. There are at least three conditions that must be met for a common policy to succeed without causing frictions among the members of the coalition. First, members must agree on the ultimate goals to be achieved through monetary policy. This issue was formally settled through the 1992 Maastricht Treaty and the ensuing ratification process by national parliaments, leading to the adoption of a goal of price stability as the primary objective for the European Central Bank (ECB).
Second, the common policy will be easier to implement if the member countries' business cycles are aligned. Monetary policy instruments are macroeconomic variables that work across the board and, therefore, cannot simultaneously be tailored to diverging cyclical conditions in the area of their jurisdiction. However, if different countries or sizable regions are at different points in the inflation cycle, then assessing the appropriate monetary policy stance becomes a much more difficult task. Large countries such as the U.S. constantly confront this problem, but the degree of economic integration and the availability of alternative policy instruments to redistribute the burden of the adjustment are likely to be poorer in the euro area than in the U.S. 
A third and perhaps more subtle issue is whether the transmission mechanism operates in a similar fashion across all the countries in the union. In particular, even if shocks hit all countries equally, their business cycles are aligned, and there is no disagreement over whether a response is needed, differences in the transmission mechanism could mean that the appropriate size and timing of the response are difficult to assess. Moreover, if the burden of adjustment is not equally shared across countries, sizable distribution differences are likely to create political tension.
The issue of how much the transmission mechanism differs across the member states of the monetary union is just beginning to attract interest. One obvious difficulty with addressing the question is the possibility of a regime switch that could have occurred with the creation of the ECB. It is possible that all past evidence on the transmission mechanism is no longer relevant because beliefs about policy will now differ.
While we concede that this is possible, we doubt that this institutional change has brought about behavioral changes in a sharp, discontinuous fashion. There is abundant evidence that people adjust their behavior gradually. In this case, collecting evidence on how agents operated in the past regime should provide some information on how they will behave in the present one.
Even in the absence of structural breaks, however, trying to conduct the relevant cross-country aggregate comparisons in the transmission mechanism is fraught with difficulties. Research on how to identify the response of a single economy to monetary disturbances in a convincing and robust fashion is just becoming available for some countries. There has been very little work on doing this for multiple countries using a common framework. In particular, to study the effects of how a common monetary policy might matter, one needs to impose a uniform monetary policy reaction function across countries and to constrain exchange rate movements. …