One of the main conclusions of the study towards single monetary policy decisions in the EMU (European Economic and Monetary Union) is that the interest rate channel is important in all Euro countries and there are significant differences in the monetary transmission mechanism. What might lead to these differences has been the theme of the some recent studies where the supply block is the main focus. In this project, we aim at providing a theoretical explanation from the demand block. Namely, we attempt to illustrate the structural distortions associated with a monetary union, such as the immobility of labour, the lack of fiscal transfer and disparate levels of public spending across the union members, may give rise to the heterogeneities in monetary transmission mechanism.
Why is such explanation important? This is due to implications of imminent expansion of the EMU towards the East. May 1, 2004, ten CEEC (Central and Eastern Europe Countries) became members of the European Union. As the next step, the CEEC aim at joining the EMU. The CEEC will also participate in the decision making on monetary policy since the date they become the member of the EMU. This expansion will take place as soon as 2006 with Estonia joining the Euro area. This means that the monetary transmission mechanism will still be different across countries, or at least across groups of countries (West and East), fiscal policy will still be uncoordinated, and labour will not be mobile across West and East.