THE EUROZONE CRISIS: THE THEORY OF OPTIMUM CURRENCY AREAS BITES BACK
The idea of this paper is taken from the research of Barry Eichengreen’s article “The eurozone crisis: the theory of optimum currency areas bites back.” The author provides the summary of the main insights, the most significant estimations about the issues of the Eurozone economy presented in the researched article, and the ways of solving them. The author also gives the assessment of the article, considering the relevance and consistency of the related arguments, and the additional aspects that need consideration with regard to the discussed theme.
The Review of the Main Limitations of the Theory of Optimum Currency Areas
Barry Eichengreen, the author of the article “The eurozone crisis: the theory of optimum currency areas bites back”, devoted it to the study of the Optimum Currency Areas (OCA) limitations and the modern issues of the Eurozone economy caused by disregard for this theory’s disadvantages. The author finds the submitted theory of the Optimum Currency Areas quite adequate and topical at the period of its creation, in the 1960s. However, in the modern world, considering current circumstances of the global economic system, the theory creates irreconcilable contradictions among the domestic economies of the countries that have become members of large economic unions. This fact partly covers the benefits that can be achieved by the members of the economic union.
In order to explain these issues, it is important to analyze the EU economy nowadays, enumerate the theory of the main Optimum Currency Areas limitations and disadvantages.
Among them are:
- The impracticability of the theory’s idea about “convergence, labor mobility and fiscal integration as preconditions for a smoothly functioning monetary union”. This thesis is explained by the differences between the economic situation considered in the theory and the characteristics of modern European economies.
- Irrelevant representation of the banks’ role in the modern economy in the OCA theory. Considering banks as tightly regulated systems, the author of the theory missed the question of monetary shocks risks caused by inadequate unauthorized banks policy and the need for banking the creation of the union, which permits to decrease and insure the risks of an ineffective policy of private banks of individual countries.
- Neglect of the problem of restructuring sovereign debts of member countries, which becomes topical in the modern EU society, as one of the main conditions of the future economic growth.
Detailed Examination of the Contradictions of the Modern Eurozone Economy, and the Ways of Their Solution
After getting acquainted with the main problems of the OCA theory, the review of the main Eurozone problems is needed. According to the author of the article, Barry Eichengreen, the issues of the EU economy were caused by an inadequate cohesion policy of the EU members. The basis of the main economic issues of the EU is significant differences of economic and industrial development between member countries. This fact leads to enormous negative circumstances for the Eurozone’s economic development. The possible solution for all the contradictions emerging from this fact is not discussed in the OCA theory, but is presented in this article as a conclusion of an earlier research.
First of all, a modern monetary union is impossible without an efficient system of banking union. It is required to regulate bank relations and cross-border capital flows between the members in order to ensure the control over dishonest domestic banks and avoid the problem of inadequate capitalization, which leads to the increase in the number of insolvent banks. One more issue of the European banking system is the development of a harmonized deposit insurance scheme, which avoids disputes among the EU members that regard it as a source of funds to rescue banks of the member countries. Also, the European Central Bank, as a tool for increasing and decreasing risks, a lender, and a liquidity provider of the last resort, needs improvement.
Another issue of the EU is limitations of a positive effect on the Eurozone economic growth caused by the improvement in labor mobility. Though in the OCA theory labor mobility is considered an efficient way of adjusting region-specific shocks, the modern situation refutes this thesis. First of all, the financial integration of modern economies increased the correlation of regional business cycles that affects the effectiveness of migration, reducing it. Second of all, another topical problem is brain drain of the higher-skilled mobile population from the Eurozone periphery to its core. This circumstance increases regional shocks, based on the differences in levels of development between member countries of the EU.
Along with the issue of differences in economic development between EU members, the problem of restructuring unsustainable debts is also important and needs a solution. This problem negatively affects the process of creating a fiscal union and the economic growth of the Eurozone. Despite political problems that demand distribution of funds among less developed economies, a significant inherited debt negates the effectiveness of coinsuring fiscal policy of the economic union. Another obstacle to the creation of an efficient fiscal union in the Eurozone is the lack of credibility. “Governments are prone to overestimating revenues – to forecasting too small an output gap – and therefore to underestimating realised deficits”. The solution to this problem is to outsource the forecast of the economic growth to an independent committee, which decreases the risks of inadequate appraisal of t economic results. The tackling of restructuring sovereign debts is more complex and difficult, but the restructuring of Greek debt shows the feasibility of market based methods of debt restructuring in the Eurozone and possible solutions.
The Assessment of the Researched Article
The researched article reflects the features and the issues that have happened in the Eurozone during the integration period. As Barry Eichengreen said, the main reason for most problems of the EU is a significant difference in the economic and production development levels between the union members. This fact is the result of a reckless expansion policy of the EU, which enables the countries with relatively low economic development level to entry the union, and is usually caused by political and non-economic factors. The EU policy, based on addressing short-term needs without considering expansion perspectives, leads to the increase of misbalances and shocks in the Eurozone.
Most of these misbalances are thoroughly discussed in the researched article. As it has been previously indicated, the most important issues are the implication of an efficient banking system that can offer the way to regulate domestic banking systems of the member states and adapt them to the European standards. The relevance of this problem immediately proved a real state of affairs in today’s economy in Europe. Recently, the most resonant theme in the world news has been the issue of restructuring Greece’s sovereign debt. The circumstances took such a turn that the risks of leaving the EU were discussed by the government of Greece. Even though the crisis was overcome, this event has become a precedent showing that the problem of banking regulation in the EU is not decided yet. To solve the problem of Greece, the cooperation of the most influential leaders of the Eurozone was needed, although, if there was a real efficient banking system, the solution of the issue would not be so challenging.
The important question, considered in this article, is the effectiveness of labor mobility in the European conditions. The author discusses the barriers and restrictions on labor mobility in Europe. The main idea is the little use of labor mobility, explained by plenty of social barriers for emigrants and the brain drain from the EU periphery to its core. This circumstance only increases the development gap between the periphery and the core, and it causes further asymmetric shocks. This idea is consistent and topical, but further clarification is needed.
This situation is caused by the changes of migration characteristics in the Eurozone. When Barry Eichengreen was writing his article, the problem of immigration from the Middle East and Northern Africa was not so serious. As a result, this fact affects the discussed question, because it can become the source of new asymmetric shocks for generations. The European policy on the issue of immigrants is based on their distribution among the members, thought, its realization is quite problematic. The periphery countries cannot find resources to provide appropriate conditions for helping immigrants and integrate them into the society, so they refuse to accept them. It causes not only economic but also political risks, worsening the relations between the members of the EU.
At the same time, the countries of the EU core achieve noticeable advantages from such a situation. For example, Germany provided labor places for immigrants, hoping to profit from low labor costs. The effectiveness of such a policy was proved by the country’s post-war economic recovery. However, for the EU members with lower economic development levels the situation is diametrically opposed. This circumstance creates conditions for the development of further asymmetric shocks and the increase of the peripfery-core economic gap.
Considering the presented arguments, one more important issue of the Eurozone, which was not addressed in the researched article, is the problem of the single EU currency. The single European currency was established in 1999, as a measure to provide deeper political and economic integration in the EU. The main limitation derived from its establishment is the inability for countries with small GDPs to affect the currency value. This fact leads to the impossibility of currency devalue, as a means to overcome current account deficits. So, the deflation as a measure of increasing the country’s relative competitiveness and decreasing its current account deficit cannot be used to provide effective ways of solving the current EU crisis. There is one more factor of asymmetric shocks in the Eurozone. The only method of resolving this issue is a single economic institution. “The EU currently does not have the economic institutions necessary for operating a federal economy because it is an aggregation of sovereign nations and not a unified political system”.
The researched article provides information about the main economic issues and risks of the EU, caused mainly by the union’s expansion policy of nonresponse and preserved absence of a single institution that regulates the members’ economies. Among them are high risks of asymmetric shocks caused by the differences in the development levels of the EU members, the absence of an effective regulation tool of the banking union, a low positive effect of labor mobility for the economic development of the Eurozone, the problem of enforcing a fiscal union, and the question of restructuring sovereign debts of the EU members Despite the fact that the researched analysis is consistent and relevant, some questions are not discussed properly for example, the world changes since the article’s publication. Such questions concern the risks of immigration from the Middle East and Northern Africa for the EU economic development and the limitations of the Eurozone economic growth caused by the establishment of the single European currency.