Endogenous Symmetry of Shocks in a Monetary Union

The monetary union issue, when assessed with the traditional inferences for optimal currency areas, misses an important dimension. Increased specialisation induced by reduced transaction costs, suggested by Krugman's lessons of Massachusetts, is only a part of the story. Even if agglomeration and inter-industry trade may occur as a result of reduced transaction costs, this tendency may be counteracted by the elimination of uncertainty associated with bilateral exchange rate variability within the monetary union.Thus, in contradiction to what is generally assumed on the basis of the reduction in transaction costs only, the European Monetary Union (EMU) is likely to foster intra-industry trade in Europe, leading to more symmetric shocks between member states. The monetary union will endogenously create the conditions of its success. Empirical evidence is provided for EU countries' bilateral trade over the period 1980–1994, using disaggregated trade data.