JPI Spring 2018

and Italy, two of the largest and most influential economic players in Europe. Consider a hypothetical
shift in the wine market, with a newfound international interest in Italian over French. Ordinarily,
these types of competitive markets would have currencies that would be reflected in their respective
exchange rates—in a monetary union though, this is not possible. This leads to out-of-sync cyclical
positions and trade imbalances between the two markets subjected to the asymmetric shock. Bibow
explains that an easy way to counter asymmetric shock involves exchange rate realignment. 10 Since
this is not an option in a monetary union, the same outcome could be achieved through wage-price
flexibility, with an “internal devaluation” in France (now that no one wants their wine anymore)
and/or the opposite in Italy (in our example, an internal increase in value).
According to Optimum Currency Area (OCA) theory, common wage bargaining—or wage
coordination—is critical in preventing asymmetric shocks and sustaining a monetary union.
Ironically, we see Germany departing from its own historical stability norm, with potentially
catastrophic effects for the Euro. Upon creation of the EU, the ECB defined price stability as an EUwide
Harmonized Index of Consumer Prices with an inflation rate of about 2 percent. In the absence
of any asymmetric shocks that require adjustment in relative competitiveness positions, this implies
that national unit labor trends should converge to 2 percent 11 . Agreement of all EU countries to
comply with this common 2 percent trend would be in line with commitment to a uniform inflation
rate, as well as signifying the avoidance of any devaluation strategies to internally compete. Bibow
states that at the start of the Euro most of Europe had fully converged to the historical German norm
of 2 percent and has stayed close to that ever since—except for Germany itself. Starting in 1996,
Germany shifted down, and established its own new, lower standard of zero nominal labor cost
inflation.
10
Bibow.
11
Maastricht Treaty, Article 103 Sec. 1.
JPI Fall 2017, pg. 29