EU european union, euro currency zone, monetary policy, productivity, inflation, exchange rate, Brexit
The currency union is frequently lumped up with the European Union itself, which aims to achieve a more political set of objectives. Regardless, the recent upheavals the Euro zone has experienced since the great financial crisis and the ensuing recession in 2008/2009, have brought into question the very existence of the currency union.
The rise of nationalism since the Brexit referendum in June 2016, as well as the recent European elections in Mai 2019 have fueled further criticism and rejection of the Euro currency. The purpose of this paper is to assess whether the Euro as a union currency has a future, and whether it would continue to generate benefits to all its members.
The paper is outlined as follows: the first section provides a literature review of papers that have been published before or on the eve of the Euro's creation as a union currency, in the early 2000s.
[...] The expression can be re-written in terms of rate of change: Δe denotes the change of real exchange rate, Δs change rate for the nominal exchange rate, while PI denotes the inflation rate. Since the nominal exchange rate is fixed, and differences in inflation rates are declining (lower standard deviation means less dispersion around the area-wide average) then the real exchange rate should also be close to zero. The figure below contradicts such a claim, and sheds some light as to the limitations of the Euro as a common currency for a diverse and heterogenous set of countries. [...]
[...] It was by no means rushed: the founding fathers of the European Union took pains to ensure that the earlier members did not face barriers to trade. The key assumption to the gradual economic and monetary integration of currency union members is that convergence will in time take care of any idiosyncrasies that dog the least performing countries, namely the Southern periphery. The Euro project draws heavily on the convergence theme, since the Maastricht treaty makes it a sine qua non condition for a given candidate country to join the Union, political or currency-based. [...]
[...] A whole set of issues, ranging from fiscal structures to social norms could explain why the Euro currency was not sustainable. Although the Eurozone has been in effect since 2002, there is a large body of literature which decries its existence and has periodically foreseen its demise: Stiglitz (2016) argues that the Euro currency is an unbalanced currency union, since core country members - like Germany- are imposing monetary and de facto fiscal policy on periphery currency members, like fiscal austerity packages. [...]
[...] Using three levels of price rigidities, the authors report below macroeconomic aggregates' reaction to a productivity shock. Figure: Impulse response - macroeconomic aggregates to productivity shock (optimal monetary policy regime) Source: Monacelli & Gali (2008) Parameter θ (theta) measures price sluggishness, using the so-called Calvo (1983) partial price indexation. A high value for the parameter assumes that a larger fraction of firms update their prices regularly, which means that there are low price rigidities. By contrast, a lower value for parameter θ suggests that there is a high level of price sluggishness, as reported in the first panel to the left. [...]
[...] Such an argument echoes those by de Grauwe (1993). He shows that the Maastricht Treaty has overt and hidden economic and political objectives it seeks to achieve through the convergence criteria imposed on candidate countries willing to join the euro union currency. These criteria are biased in favor of price stability (low inflation) and fixed budget deficits, are formulated in such a way that the dominant economy in the European Economic Area, Germany, perpetuates its leadership, and imposes discipline on other currency union members to follow her lead in that respect. [...]
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