REGIONAL NON-ADJUSTMENT AND FISCAL-POLICY

How will countries handle idiosyncratic macroeconomic shocks under the ingle currency? Since the regional adjustment patterns currently prev ailing within European currency unions are likely to prevail at the na tional! level under the single currency, looking at the ways in which European countries react to internally asymmetric shocks today provide s a goon preview for the answer to that question. In this paper, we co mpare the USA with Germany, Italy and the UK, and with Canada, which i s closer to Europe than the USA in its labour market and fiscal instit utions. Europe's (and to some extent Canada's) model of regional respo nse differs from that of the USA. Changes in regional real exchange ra tes are small in all countries. Outside of the USA, however, there is more reliance on interregional transfer payments, less on labour migra tion, and the pace of regional adjustment appears to be slower. If EMU aims at the same dpp) ee of economic and social cohesion that its con stituent nations enjoy today, this suggests that its members may find it hard to resist the eventual extension of existing EU mechanisms of income redistribution - a transfer union. We propose an alternative st rategy based on a relaxed Stability Pact, further strictures against c entral EU borrowing, labour mal kef and fiscal reform, and the issuanc e by individual member states of debt indexed to nominal GDP.