United in Currency, Divided in Growth: Dynamic Effects of Euro Adoption

TL;DR

This paper uses advanced machine learning methods to analyze the long-term economic growth effects of euro adoption, revealing average growth reductions and significant heterogeneity based on country characteristics.

Contribution

It introduces a novel causal inference approach combining causal forests with fixed effects to estimate dynamic, heterogeneous effects of euro adoption on growth.

Findings

Euro adoption reduces GDP growth by 0.3-0.4 percentage points on average.

Effects appear shortly after adoption and stabilize after about a decade.

Lower-income countries experience larger and more persistent growth shortfalls.

Abstract

Does euro adoption affect long-run economic growth? Existing evidence is mixed, reflecting limited treated countries, long horizons that challenge inference, and heterogeneity across member states. We estimate causal dynamic and heterogeneous treatment effects using Causal Forests with Fixed Effects (CFFE), a machine-learning approach that combines causal forests with two-way fixed effects. Under a conditional parallel-trends assumption, we find that euro adoption reduced annual GDP growth by 0.3-0.4 percentage points on average. Effects emerge shortly after adoption and stabilize after roughly a decade. Average effects mask substantial heterogeneity. Countries with lower initial GDP per capita experience larger and more persistent growth shortfalls than core economies. Weaker consumption and productivity growth contribute to the overall effect, while improvements in net exports partially offset these declines. A two-country New Keynesian DSGE model with hysteresis generates qualitatively similar patterns: one-size-fits-all monetary policy and scarring mechanisms produce larger output losses under monetary union than under flexible exchange rates. By jointly estimating dynamic and heterogeneous treatment effects, the analysis highlights the importance of country characteristics in assessing the long-run consequences of monetary union.