Asymmetries in housing and financial market institutions and EMU

Despite convergence pressures, differences in housing and financial market institutions across the 15 member states of the European Union are still enormous. This paper argues that they have profound effects on the responsiveness of output and inflation in the different countries to changes in short-term interest rates, as well as to asset market shocks of external origin. The economic reasoning behind this claim is set out and the institutional differences are described. The paper assesses the sometimes conflicting empirical evidence on this issue. Barriers to convergence and implications for labour market flexibility are discussed. The UK, Ireland, Finland and Sweden tend to cluster at one extreme of the relevant institutional characteristics. The paper includes a set of proposals for institutional reforms to reduce the tensions within EMU and the potential for instability in these economies entailed by EMU membership. The paper connects the symptoms of overheating in the Eurozone observed in mid-2000 with our analysis and concludes by reviewing prospects for the UK.