The International Monetary Fund (IMF) has warned of storm clouds gathering over the global economy. The threat of a US-China trade war, the risk of a ‘no deal’ Brexit, and the febrile state of international politics have IMF economists concerned. In Europe, the latest industrial activity numbers from Germany have raised fears that the biggest economy in the EU might be heading for recession. Meanwhile, the European Central Bank (ECB) has withdrawn the prop of quantitative easing. Have the various structural problems and contradictions of the Euro been patched up since the Eurozone crisis? Or, if the global economy stutters, could troubles with the Single Currency flare up again?
What do our readers think? One of our commenters, Bob, sent us a comment arguing that European economies are too different for the Euro to work. He argues: “A normal economy that is unhealthy would decrease the value of their currency to match their economic position. But due to the fact that the Euro is a currency used by almost all EU member states, the currency’s value is dependent on all economies and can’t be devalued. The artificial process of quantitative easing is what keeps the currency stable.”
To get a response, we put Bob’s comment to Tim Worstall, blogger, freelance journalist, and Fellow at the free market neoliberal Adam Smith Institute. How would he respond?
This is true but sadly it’s even worse. A single currency means, by definition, a single monetary policy. The various eurozone economies are indeed different, they react to external stimuli differently. This is all covered in the idea of “optimal currency areas” and the eurozone isn’t one.
For example, Germany has largely fixed rate mortgages, the UK largely floating rate. So, a change in interest rates affects all UK mortgages immediately, it only affects German ones as they are newly taken out. The British economy is thus much more sensitive to a change in interest rates than the German – this is one of the reasons Gordon Brown gave for not joining the euro. It’s this difference which triggered the Irish and Spanish property booms – Germany needed low interest rates around the introduction of the euro, those two countries definitely didn’t. From that non-optimality of the currency area came the later collapse in those two countries.
To get another perspective, we put the same comment to Jeromin Zettelmeyer, Senior Fellow at the Peterson Institute for International Economics and former director-general for economic policy at the German Federal Ministry for Economic Affairs and Energy. What would he say to Bob?
I think Bob has a point. So, when countries form a currency union, they lose a degree of flexibility to deal with those differences, that is definitely true. Now, the question is whether that more than offsets the advantages of being in a currency union; having the same currency is good for trade, and also by being in a currency union the various members benefit from a high quality institution, which is the European Central Bank, which has credibility and will, over time, achieve lower real interest rates than most members would have had on their own, making the environment more growth-friendly.
Nonethless, Bob’s point is well taken. So, in order to deal with these differences that would generally have resulted in exchange rate movements, you need a fair amount of flexibility within the currency union. So, flexibility of the real economy, which requires wage and price changes, and it also requires fiscal policies at the national level that can ensure that discrepancies between the business cycles of various countries that would typically be dealt with by national central banks are dealt with by fiscal policy. And, we’ve had problems with both in the Euro area, and part of the Euro area reform project is about addressing those problems; in particular, and here views differ, either by restoring the ability of national fiscal policies to deal with these differences across countries (so there’s a conservative agenda which says what countries should be doing is regaining fiscal space so they can do this; everyone for themselves), or they by creating some kind of fiscal mechanism that can transfer resources from the stronger to the weaker countries at times of stress, and then vice-versa when the other countries are in stress, so it need not be a permanent transfer…
We also had a comment from Protesilaos who says an orderly exit from the Single Currency is not possible. He argues that the first country that opts out will “trigger a chain reaction in the banking sector… which will see private banks and other corporations falling one after the other just like [dominoes]. Moreover, the markets will begin to speculate over which will be the next country to exit, there will therefore be immense speculative pressures which will eventually drive more countries out until the point where the currency union collapses, leaving behind chaos…”
How would Tim Worstall respond?
Yes, exit will be very difficult. Not impossible, just very painful. Greece should certainly have left as the banking system was already bust and the pain already caused. If Athens had done what Iceland did – default on the debt, devalue the new drachma – then the pain wouldn’t have been much worse than it was. But the crisis would be over and well into the past now – as it is in Iceland.
And how would Jeromin Zettelmeyer respond to the same comment?
Yes, I basically agree with Protesilaos. So, if any country left that would trigger tremendous stress, both for that country itself and for other members that would be viewed as possibly being candidates for leaving themselves, perhaps for similar reasons. So, it is a very daunting and dangerous thing to contemplate the Euro breaking up. That said, if it ever happened obviously there would be a policy reaction that would try to minimise the damage. Nevertheless, it’s completely uncharted territory and, in my view, something that should not happen. So, essentially, I agree with Protesilaos.
Should we give up on the Euro? Is it even possible to scrap the Single Currency, or would the economic impact be too painful? Let us know your thoughts and comments in the form below and we’ll take them to policymakers and experts for their reactions!