Flexibility versus Stability: A Difficult Trade-Off in the Eurozone

CEPS Working Document, No. 422, 2016

34 Pages Posted: 20 May 2016

See all articles by Centre for European Policy Studies

Centre for European Policy Studies

Centre for European Policy Studies (CEPS)

Paul De Grauwe

CESifo (Center for Economic Studies and Ifo Institute for Economic Research); London School of Economics & Political Science (LSE); Centre for Economic Policy Research (CEPR)

Yuemei Ji

Brunel University London

Date Written: April 29, 2016

Abstract

Optimal currency area (OCA) theory has been influential in pushing eurozone countries towards structural reforms to make product and labour markets more flexible. The underlying assumption of the OCA prescription for structural reform is that asymmetric shocks are permanent. However, when shocks are temporary it does not follow that more flexibility is the answer. When shocks are the result of business-cycle movements, the way to deal with them is by stabilisation efforts. This paper provides empirical evidence that suggests that the biggest shocks in the eurozone were the result of business-cycle movements. These were relatively well synchronised, except for their amplitude. We argue that efforts to stabilise business cycles should be strengthened relative to the efforts that have been made to impose structural reforms, with consideration given to the implications for the governance of the eurozone.

Keywords: Optimal currency area, OCA, eurozone

Suggested Citation

Policy Studies, Centre for European and De Grauwe, Paul and De Grauwe, Paul and Ji, Yuemei, Flexibility versus Stability: A Difficult Trade-Off in the Eurozone (April 29, 2016). CEPS Working Document, No. 422, 2016, Available at SSRN: https://ssrn.com/abstract=2782351

Centre for European Policy Studies

Centre for European Policy Studies (CEPS) ( email )

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Paul De Grauwe (Contact Author)

CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

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London School of Economics & Political Science (LSE) ( email )

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Centre for Economic Policy Research (CEPR)

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United Kingdom

Yuemei Ji

Brunel University London ( email )

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Uxbridge, Middlesex UB8 3PH
United Kingdom

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