Banking union

The Euro Area in the Age of COVID-19

The founders of the euro had little doubt about the common currency’s role as a foundation for European peace and prosperity. Yet, they were not Pollyannas. For years before the start of monetary union in 1999, economists had warned that the member states of the European Union do not constitute an “optimum currency area” (see, for example, Milton Friedman). This means that a single policy interest rate might exacerbate, rather than mitigate, economic differences, creating severe strains among euro area countries.

Since the euro’s beginning, European leaders hoped and expected that as tensions arose, member states would come closer together—integrating their economies and financial systems, sharing burdens and risks. To a considerable extent, experience has borne out these hopes. Despite enormous challenges, no country has abandoned the euro and reintroduced a national currency. Today, an entire generation of people has come of age knowing only the euro. Moreover, as of November 2019, popular support for the single currency among euro area residents was at a record 76%, with sizable majorities in each member state (see Eurobarometer 92, pages 32-33).

And yet, over the past two decades, there has been only grudging progress toward a truly resilient monetary union. Politically and financially, the euro area remains divided. The COVID-19 crisis brings renewed tensions. With it comes a harsh reminder that standing still is simply not an option.

In this post, we review the progress toward completion of the European monetary union, and note key gaps that remain….

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Italeave: Mother of all financial crises

After years of calm, fears of a currency redenomination—prompted by the attitudes toward monetary union of Italy’s now-governing parties and the potential for another round of early elections—revived turbulence in Italian markets last week. We have warned in the past that an Italian exit from the euro would be disastrous not only for Italy, but for many others as well (see our earlier post).

And, given Italy’s high public debt, a significant easing of its fiscal stance within monetary union could revive financial instability, rather than boost economic growth. Depositors fearing the introduction of a parallel currency (to finance the fiscal stimulus) would have incentive to shift out of Italian banks into “safer” jurisdictions. Argentina’s experience in 2001, when the introduction of quasi-moneys by the fiscal authorities undermined monetary control, is instructive….

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To Form a More Perfect Union

On 31 May 2018, Vítor Constâncio completes 18 years on the Governing Council of the European Central Bank (ECB)—8 as Vice President and 10 as Governor of the Bank of Portugal before that. Ahead of his departure, Vice President Constâncio delivered a valedictory address setting out his views on what needs to be done to make European Monetary Union (EMU) (and what people on the continent refer to as the “European Project”) robust.

Before we get to his proposals, we should emphasize that we continue to view political shifts as the biggest challenge facing EMU (see our earlier posts here and here). The rise of populism in recent euro-area member elections is not conducive to the risk-sharing needed to sustain EMU over the long run. Without democratic support, investor fears of redenomination risk—associated with widening bond yield spreads and, possibly, runs on the banking systems of some national jurisdictions—will continue to resurface whenever political risks spike or local economic fortunes ebb. This latent vulnerability—resembling that of a fixed-exchange rate regime with free movement of capital—diminishes the prospect for strong and stable economic growth in the region as a whole.

Turning to the need for change, the current framework has three significant shortcomings…

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After Greece: Saving EMU

Euro-area leaders announced yet another agreement with Greece this morning. However, the survival of the euro area has never been about the fate of Greece. Instead, it is whether the Europeans will implement the reforms necessary to keep the euro area together. If they do, the common currency will endure. If they don’t, then the euro may not survive the next big adverse shock...

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The Importance of Being Europe

If Oscar Wilde were still around, he could write a wonderful comedy about European Economic and Monetary Union (EMU). Like the life of his protagonist, Ernest John, the evolution of EMU is rarely pure and never simple. But it would take a Wilde imagination to see exactly how EMU gets to a happy ending.

Despite its name, EMU was not and is not primarily an economic endeavor...


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