The Impact of Brexit on the Stability of the Euro Area

Abstract

What is the impact of Brexit, which is the British decision to withdraw from the European Union (EU), on the stability of the euro area? This is a difficult question that, given the uncertainty surrounding it, may benefit from a novel approach. Euro area asymmetries depend on the degree of integration among euro member states or, more specifically, on the relative strength of core and periphery sets. This paper argues that assessing the “core content” for each member state may help address questions about the stability of the euro area. We first analyse the extent to which economic activity in the United Kingdom is synchronised with that in the euro area and we find it increased with the single currency. We then discuss the need for going beyond this standard analysis of business cycle synchronisation. We construct a “core-ness index” (CMCI) which shows that the core-periphery pattern has significantly weakened after the introduction of the euro. To better characterize this result, we investigate the CMCI determinants and find it is strengthened by euro membership and weakened by product market regulation. In this light, the paper concludes with novel policy implications to increase the “core content” of members states and, consequently, shore up the stability of the euro area after Brexit.