EMU Can’t Fly

For the next couple of sessions we turn our attention to foreign currency and capital flows. There will be something for everyone: accounting revision, trade and financing riddles, geeky equations, financial arbitrage, politics and institutional design, model simulations. What’s not to like?

Our feature video takes up just one of the threads covered; specifically, whether structural flaws are tainting the Eurozone (euro area). The video focuses on one particular view that not all economists would agree with. Some, for example, would say that the region’s problems reflect bad policy choices rather than poor structure. However, it is hard to deny that Economic and Monetary Union is not really a union at all. It is a dog’s dinner that serves countries with very different economic structures, languages, legislatures, customs and regulations.

For sure, there is a huge common purpose – primarily to bind social and political ties so as to prevent a rerun of European wars that have plagued the region for many centuries. However, the project has too often required large, and painful, sacrifices that undermine essential co-operation and trust. The GFC delivered severe recessions (via required internal devaluations) in the so-called European “periphery”, creating bitterness and fuelling old rivalries between the North and South. For many economists this is no surprise since the Eurozone is hardly a convincing optimal currency area.

As the interviewee makes clear, and I agree, it is not the euro per se that is the problem. Rather, the flaw arises from the institutional setup of the Eurozone itself, principally revolving around the lack of policy flexibility.

The key problems areas are,

  • inadequate provisions for national central banks to support liquidity-strained governments
  • no sign of fiscal integration
  • legal and social constraints on labour mobility
  • insufficient supply of euro safe assets

Perhaps there is too much impatience. It takes a long time to move from old boundaries to new frontiers. The US in its infancy was arguably in a similar place to where EMU is now. But, almost twenty years on since the euro’s launch, there is precious little sign of governments engaging in supportive fiscal transfers. Full political union is unlikely and possibly unwarranted. That said, it would be a catastrophe if EMU itself were dissolved – especially in the midst of social and/or economic stress. The only way now is to push forward and reform: but so much more needs to be done on banking unions, fiscal co-ordination and structural integration if further EMU crises are to be contained.

On a more light-hearted note, another problem with the Eurozone is that few are actually clear as to what and where it is! Formally, the euro area consists of those Member States of the European Union that have adopted the euro as their currency.

It sounds straightforward but you do not have scratch far below the surface before confusion arises. Take Scandinavia…

  • Finland is an EU member, uses the euro as its principal currency and so is a fully signed-up member of the euro area.
  • Norway is not an EU member, retains its own currency and so is not in the euro area.
  • Sweden is an EU member, retains its own currency and has not yet adopted the euro. That said, Sweden is obliged to use the euro once it fulfils the necessary conditions but, until then, it remains outside the euro area.
  • Denmark is in a similar, but not identical, position as Sweden in that it is outside the euro area. Denmark is an EU member, retains its own currency but the krone shadows the euro. However, unlike Sweden, Denmark negotiated an opt-out from the euro and thus is not obliged to introduce it.

Are there European countries that are not EU members but who use the euro as their principal currency? Yes, the European microstates of Vatican City, Andorra, Monaco and San Marino all officially use the euro – with formal EU agreements – but are not part of the EU (hence, not part of the euro area). Kosovo and Montenegro both adopted the euro unilaterally in 2002 although, given the absence of an EU agreement, the currency is not de jure legal tender just de facto.

Then there is the issue of whether a country needs to be in Europe to be a euro user. Indeed, can you be outside Europe and yet still qualify as a euro area member?

Euro users such as the Canary Islands do not belong to Europe geographically but are an autonomous community of Spain and so qualify as part of the EU and the euro area. Similar considerations apply to the Azores and Madeira (in the Atlantic and belong to Portugal), Mayotte and Réunion (in the Indian Ocean and belong to France). French Guiana in South America uses the euro, qualifies as an EU member (via France) and is part of the euro area. But then Saint Pierre and Miquelon – just off the eastern coast of Canada – are formally part of France and use the euro but, as an “overseas collectivity” rather than “overseas departments”, do not qualify as members of the EU and thus are not formally part of the euro area.

So here’s a suggestion. Why not take a field trip to the Caribbean and determine the precise EU/euro area status of Guadeloupe, Martinique, Saint Martin and Saint Barthélemy? Research conclusions, please, on pretty postcards.

25 Apr 2019