Economic Report President

members agreed in a separate Growth and Stability Pact, membershiprequires maintenance of a disciplined fiscal policy. (According to thepact, fines may be imposed on countries found to be running excessivedeficits.) Participation in EMU thus eliminates national monetary policyand limits the scope of fiscal policy as a stabilization tool. This lossof macroeconomic tools to address cyclical unemployment makes moreurgent the need for European structural reforms, for example toincrease flexibility in the labor market. In this sense it is hoped thatEMU might serve as discipline to nudge European countries to implementstructural reforms more rapidly and eliminate impediments tosustained growth.The creation of a large region of monetary stability is a commendableculmination of the 50-year process of economic, social, and politicalintegration that has taken place in Europe. Indeed, the originalmotivation for economic integration in Europe was to ensure that thecountries in the heart of Europe, which had fought three major warsover the preceding 100 years, never do so again. This is one reasonwhy, in historical perspective, European integration has always beenin the political interest of the United States. But the United States willalso benefit in an economic sense, as a trading partner with Europe,from strong economic performance there, which the single-currencyproject may enhance in the long run. As long as Europe remains opento trade, what is good for Europe economically is good for Americans.However, EMU also entails some potential costs. Most important,the loss of monetary autonomy deprives countries of a tool to respondto asymmetric national shocks —unexpected economic developmentsthat affect some countries differently than others. Similarly, exchangerate changes are another instrument for coping with such shocks, butwith EMU this tool will also no longer be available. Without thesetools, flexibility of wages and labor mobility across regions and industriesare the major mechanisms of adjustment. But labor mobility ismuch lower among the nations of Europe than, for example, among theAmerican States. Fiscal policy can also play a stabilization role, butagain, the rules for EMU membership constrain countries’ ability touse that tool. Finally, Europe also lacks a centralized system of taxesand transfers comparable to that of the United States to cushionagainst regional and national shocks. Limited labor mobility, structurallabor market rigidities, and decentralized and constrained fiscalpolicies could imply that Europe does not satisfy the criteria for anoptimum currency area (Box 7-2) as clearly as do the States of theUnited States.Although these potential costs of EMU have some relevance, some ofthe objections to EMU have been exaggerated. For example, althoughmonetary policy is a potent policy tool for mitigating cyclicalunemployment (that caused by shocks affecting aggregate demand fora country’s goods and services), it has little long-run impact on294