Break up of the Euroarea: Scenarios and Possibilities

Though this paper has been on the highly recommended reading list for a while now, I only managed to read it now. Written by Barry Eichengreen, it is a must read paper on problems in Euro area:

The possibility of the breakup of the euro area was already being mooted even
before the single currency existed.2 These scenarios were then lent new life around the middle of the decade when appreciation of the euro against the dollar and problems of slow growth in various EU member states led national politicians to blame the European Central Bank for disappointing economic performance. Highly-placed officials, including possibly members of the governing council of the German central bank, reportedly discussed the possibility that one or more participants might withdraw from the monetary union. How seriously should we take these scenarios? And how much should we care  in other words, how significant would be the economic and political consequences?

 What are the findings?

The conclusion of the author is that it is unlikely that one or more members of the
euro area will leave in the next ten years and that total disintegration of the euro area is more unlikely still.5 The technical difficulties of reintroducing a national currency should not be minimized. Nor is it obvious that the economic problems of the participating member states can be significantly ameliorated by abandoning  the euro, although neither can this possibility be dismissed. And even if there are immediate economic benefits, there may be longer-term economic costs, and political costs of an even more serious nature. Still, as Cohen (2000) puts it, “In a  world of sovereign states, nothing can be regarded as truly irreversible.” Policy analysts should engage in contingency planning, even if the contingency in question has a low probability.

He points there are all kinds of issues- technical, political and economic – each very difficult to overcome:

While it is  widely argued that the technical and legal obstacles to a country unilaterally reintroducing its national currency are surmountable, it will be argued here that the associated difficulties could in fact be quite serious. To be sure, there are multiple historical examples of members of monetary unions introducing a national currency. It has also been suggested that the legal problems associated with the redenomination of contracts can be overcome, as they were when the ruble zone broke up or when Germany replaced the mark with the reichsmark in 1923-4. But changing over from an old money to a new one is more complicated today than in Germany in the 1920s or the former Soviet Union in the 1990s. Computer code must be rewritten. Automatic teller machines must be reprogrammed. Considerable advance planning will be required for the process to go smoothly (as was the case with the introduction of the physical euro in 2002).

Moreover, abandoning the euro will presumably entail lengthy political debate and passage of a bill by the national parliament or legislature, also over an extended period of time. And, all the while, there will be an incentive for agents anticipating the redenomination of their claims into the national currency, followed by depreciation of the financial-market collapse. Limiting the negative repercussions would be a major technical and policy challenge for a government contemplating abandonment of the euro.

The economic obstacles revolve around the question of how debt servicing costs, interest rates spreads, and interest-rate-sensitive forms of economic activity would respond to a country’s departure from the euro area.

The political costs are likely to be particularly serious. The Treaty of European Union makes no provision for exit. Exit by one member would raise doubts about the future of the monetary union and likely precipitate a further shift out of eurodenominated assets, which would not please the remaining members. It might damage the balance sheets of banks in other countries with investments in the one abandoning the euro. Diplomatic tension and political acrimony would likely follow, and cooperation on non-monetaryissues would suffer.

Great paper. Full of insights…

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One Response to “Break up of the Euroarea: Scenarios and Possibilities”

  1. Akshat Says:

    Also take a look at the latest on EUVOX on how they liken an exit from eurozone to the argetinian situation of 2002. A very useful way to look at where potential disuruptions might come from if one state were to exit/was ejected.

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