Time-varying criteria for monetary integration: evidence from the EMU

How can we determine whether an economy will benefit from membership in a monetary union? While economic theory has proposed a number of widely accepted criteria, virtually all empirical studies apply them as if they were time-invariant. The purpose of this paper is to show that unless the dynamic nature of these criteria is explicitly taken into account, the results will be flawed and misleading. We focus on 13 EU countries and two specific criteria: the relative size of output shocks and their synchronization. Using quarterly data from the 1961:1 to 1997:4 period, we show that the parameters relevant to these criteria have exhibited substantial variability over time for essentially all countries in our sample. Our time-varying parameters allow us not just to avoid the flaws of the conventional method, but also to discuss the optimal timing of forming or joining a monetary union.