Adopting the Euro: A Synthetic Control Approach

Abstract

We investigate whether joining the European Monetary Union and losing the ability to set monetary policy affected the economic growth of Eurozone countries. We use the synthetic control approach to create a counterfactual scenario for how each Eurozone country would have evolved without adopting the euro. We let this matching algorithm determine which combination of other developed economies best resembles the pre-euro path of twelve Eurozone economies. Our estimates suggest that there were some mild losers (France, Germany, Italy, and Portugal) and a clear winner (Ireland). Nevertheless, a GDP decomposition suggests that the drivers of the economic gains and losses are heterogeneous. In particular, our results show that adopting the euro spurred government consumption and deterred investment and private consumption. The common currency also stimulated trade for most cases but only Germany and Ireland bear positive net trade benefits.

Keywords: Monetary union; Eurozone; Synthetic control method; GDP decomposition; Macroeconomic performance

JEL Classification: E30, E60, C32, E02, E52, E65