Mundell in 3D, synchronization of supply and demand shocks among sectors not countries, with application to CEECs

We follow recent Optimum Currency Area empirical literature and investigate the correlation of supply and demand shocks between the individual new EU member countries and the ‘EU-core’. Treating the whole economy as one sector this is a standard exercise based on Mundell’s original insight that monetary unification can be welfare improving if (among other things) two or more countries contemplating unification face similar economic disturbances. However, treating the economy of each country as a single sector precludes gaining further insights from the empirical exercise. For this purpose, we propose a novel methodology which treats the economy of each country as a collection of three distinct sectors. This allows us to go beyond the standard results usually presented in the form of international correlation of supply and demand shocks. The methodology combines two pieces of information about each sector in a given economy. The first is the international correlation of sector-specific supply and demand shocks. This information is valuable in itself from the economic policy perspective, as it identifies the most and least internationally synchronized sectors, that is, the sectors that are most and least likely to benefit from monetary unification. The second piece of information is the sector-specific weights used for aggregation across sectors in a given country. While interesting in itself, when combined with the first this piece of information points to sectors that are more and less responsible for the final result one obtains from the empirical exercise. The international correlation of supply and demand shocks is a result common to the standard methodology and our methodology, so the latter can also be seen as a robustness check of the former. Copyright Springer Science+Business Media, LLC. 2012