Highbrow opinion is like a hunted hare; if you stand long enough it will come back to the place it started from. Dennis Robertson

We discuss the origins of the Greek financial crisis as manifested in the growing fiscal and current-account deficits since euro-area entry in 2001. We then provide an investigation of spreads on Greek relative to German long-term government debt. Using monthly data over the period 2000 to 2010, we estimate a cointegrating relationship between spreads and their long-term fundamental determinants, and compare the spreads predicted by this estimated relationship with actual spreads. We find periods of both undershooting and overshooting of spreads compared to what is predicted by the economic fundamentals. JEL Classification: E63; G12

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We compare monetary union to flexible exchange rates in an asymmetric, three-country model with active monetary policy. We find that countries with a high degree of nominal wage rigidity benefit from monetary union, especially when they join other, similarly rigid countries. Countries with relatively more flexible wages tend to be worse off in unions with countries that have more rigid wages. We examine France, Germany and the UK and find that the welfare implications of monetary arrangements depend more on the degree of wage asymmetry than on other types of asymmetries and that the higher wage flexibility in the UK would make its participation in EMU costly.Several members of the European Union formed a monetary union in 1999. Others opted to remain outside. A great deal of academic and political debate has surrounded this event. It has focused both on the effects of EMU for macroeconomic stability in its participant countries and on the wisdom of remaining outside once a currency union has been formed.This debate has taken place more or less within the traditional Mundell-Fleming model and the associated optimum currency area (OCA) literature. A key result that has emerged from this literature (de Grauwe, 2001) is that the cost of participation in monetary union increases with:(a) dissimilarities in economic structure, and in particular, in the degree of asymmetry in the shocks, (b) the degree of nominal rigidities.Countries with rigid nominal wages (prices) and asymmetries may want to retain the exchange rate instrument in order to have an adjustment mechanism that could serve as a substitute for the lack of nominal price adjustment; see also Friedman's (1953) case for flexible exchange rates.The choice of the exchange rate regime is a special case of the more general issue of optimal monetary policy in an open economy. There is a new and fast expanding literature that uses the New Keynesian Model (NKM)to investigate the performance of alternative open economy monetary policy rules, the macroeconomic and welfare properties of alternative exchange rate regimes (Collard and Dellas, 2002;Devereux and Engel, 2003;Duarte, 2003;Kollmann, 2002) and the welfare implications of different degrees of international policy coordination (Canzoneri et al., 2002;Clarida et al., 2002;Pappa, 2004;Obstfeld and Rogoff, 2001). The message that emerges from this literature concerning the value of the exchange rate instrument is more mixed. The results depend on the currency denomination of trade, the structure (completeness) of financial markets, the type of policy rule considered and differences in size across countries. * We thank Mike Wickens, Milton Friedman and three anonymous referees for numerous valuable suggestions. Any remaining errors are ours.

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