- year ) caplet volatility. on average the term structure of volatility is relatively flat, making this a reasonable approximation for the one - year volatility. hordahl, p. and o. tristani ( 2007 ) “ inflation risk premia in the term structure of interest rates ”, ecb working paper series no 734, and garcia, j. a., and t. werner ( 2009 ), “ inflation risks and inflation risk premia ”, ecb working paper series, forthcoming. ciccarelli, m. and j. a. garcia ( 2009 ), “ what drives euro area break - even inflation rates? ”, ecb working paper series no 996. particular, actual inflation readings are the main reason for movements in short - term beirs, but play no role in explaining long - term ones. thus, the expected brief spell of negative overall inflation in the coming months does not seem to have no noticeable impact on longerterm beirs, thereby supporting the idea of well - anchored expectations in the euro area. at least so far. overall, the evidence suggests that the euro area is a long way from generalised, persistent and expected deflation. the severity of the recession points to inflation remaining low in the next two years or so, but this is not expected to lead to the emergence of outright deflation. in any case, continuous monitoring is needed, as history shows ‘ that deflation and deflation expectations can take root surprisingly quickly ’. 11 the overall assessment is supported by a number of other indicators, in particular by developments in the labour market. in early 2009, wage growth remained fairly robust, although this may partly reflect hysteresis ( slide 16 ). in particular, the annual growth rate of compensation per employee fell to 1. 9 % in 2009q1, down from 2. 8 % in the fourth quarter. 12 similarly, the rally in commodity prices will help to offset downward pressures on consumer prices. for instance, since the beginning of 2009 oil prices have more than doubled even when measured in euro. 3. monetary indicators while economic analyses already provide a clear indication of the short to medium - term risks of a deflationary scenario, it might be helpful to compare them with the signals emanating from the monetary analysis. this notion is explicitly recognised in the ecb ’ s monetary policy strategy, where monetary trends provide information on price developments over the medium to longer term and serve as a

“ runs ” on bank and sovereign debt absent central bank support. 6 such adverse feedback loops turned recessions into depressions in several european countries in recent years. what makes a successful currency union? the success of a currency area hinges on whether its features mitigate the costs of losing the flexibility that comes from an independent monetary policy. these features generally promote the alignment of economic cycles, and the maintenance of price and financial stability within the union. the most obvious feature is the degree of similarity amongst members. similar economies won ’ t suffer from a “ one size fits all ” monetary policy. 7 surprisingly, a review of major currency areas suggests that similarity is neither necessary nor sufficient for success. for example, the industrial structures of the core and periphery of the euro area are more similar than those of the constituents of canada or the us ( table 1 ). yet few would argue that the euro area is the most effective currency union of the three. conversely, the canadian monetary union works well despite having substantially larger industrial variation than even the us. 8 the similarity of the industrial structure of scotland and the rest of the uk depends on how offshore oil is allocated. with oil split on a per capita basis scotland and the rest of the uk look about as similar as the core and periphery of the euro area ; but with oil split on a geographic basis they look about as diverse as the united states ( table 1 ). despite any differences, the close integration of the scottish and rest of uk economies has helped ensure that their economic performance has been very similar over a long period – output growth is highly correlated ( chart 1 ). 9 so theory notwithstanding, being similar doesn ’ t necessarily help and being different doesn ’ t necessarily hinder. this suggests we should look elsewhere for the ingredients of a successful union : to the mobility of labour, capital and goods ; to institutional structures promoting financial stability ; and to institutions that mutualise risks and pool fiscal resources. an economic union with free movement of labour, capital and goods the “ five tests ” formulated by the uk government to analyse the merits of joining the euro in 2003 were crafted in large part around the degree of integration of the uk and the euro area. 10 that is because greater openness and integration within a currency union not only enhances these dynamics were in operation in the recent euro area crisis, until the announcement of the ecb ’ s outright monetary transactions. members are similar when they experience similar shocks and respond to the same shock in similar ways. that reduces