Economics Essay 35: Joining the Euro

 Explain, using a diagram, how an EU member could stabilise its currency against the euro prior to joining the eurozone.

Stabilizing a currency against the euro prior to joining the eurozone involves maintaining a fixed or relatively stable exchange rate between the national currency of an EU member and the euro. Let's define the key terms involved:

1. Eurozone: The eurozone is a monetary union consisting of countries that have adopted the euro as their official currency. These countries share a common monetary policy, overseen by the European Central Bank (ECB), and have given up their national currencies in favor of the euro.

2. Exchange rate: The exchange rate is the value of one currency in terms of another. It represents the rate at which one currency can be exchanged for another. In this context, it refers to the rate at which the national currency of an EU member is converted into euros.

To stabilize its currency against the euro, an EU member can employ several measures:

1. Fixed exchange rate: The country can establish a fixed exchange rate regime, where its national currency is pegged directly to the euro at a specific exchange rate. This requires a commitment to maintain the fixed rate through active intervention in the foreign exchange market by the country's central bank.

2. Currency board arrangement: A currency board arrangement involves issuing a domestic currency that is fully backed by a reserve of euros. The domestic currency is issued at a fixed exchange rate, and the central bank commits to maintaining the fixed rate by holding adequate reserves of euros.

3. Monetary policy coordination: The EU member can align its monetary policy with that of the eurozone to maintain stability. This may involve adopting similar interest rate policies, inflation targets, or exchange rate policies that support the desired stability against the euro.

4. Capital controls: The country may implement capital controls to regulate the flow of capital in and out of the country. These controls can help manage speculative activities and reduce volatility in the exchange rate.

5. Macroeconomic policies: The EU member can pursue sound macroeconomic policies, such as fiscal discipline, maintaining price stability, and implementing structural reforms to improve the competitiveness of its economy. These policies contribute to maintaining confidence in the currency and its stability against the euro.

It is important to note that stabilizing the currency against the euro prior to joining the eurozone is typically a temporary measure. Once a country meets the necessary criteria and decides to adopt the euro as its currency, it will transition to the euro and no longer have an independent national currency.

Examples of countries that have stabilized their currencies against the euro prior to joining the eurozone include Bulgaria, which has employed a currency board arrangement, and Denmark, which maintains a fixed exchange rate within a narrow fluctuation band against the euro.

Overall, stabilizing a currency against the euro prior to joining the eurozone requires careful policy coordination, effective management of exchange rate mechanisms, and adherence to sound macroeconomic principles. It allows the country to establish a foundation of stability and credibility as it prepares for full integration into the eurozone.

The Buddha Speaks - Brexit: How do you interpret a referendum?

The Crisis of European Democracy

by Amartya Sen

IF proof were needed of the maxim that the road to hell is paved with good intentions, the economic crisis in Europe provides it. The worthy but narrow intentions of the European Union’s policy makers have been inadequate for a sound European economy and have produced instead a world of misery, chaos and confusion. 

There are two reasons for this.

First, intentions can be respectable without being clearheaded, and the foundations of the current austerity policy, combined with the rigidities of Europe’s monetary union (in the absence of fiscal union), have hardly been a model of cogency and sagacity. Second, an intention that is fine on its own can conflict with a more urgent priority — in this case, the preservation of a democratic Europe that is concerned about societal well-being. These are values for which Europe has fought, over many decades.

Certainly, some European countries have long needed better economic accountability and more responsible economic management. However, timing is crucial; reform on a well-thought-out timetable must be distinguished from reform done in extreme haste. Greece, for all of its accountability problems, was not in an economic crisis before the global recession in 2008. (In fact, its economy grew by 4.6 percent in 2006 and 3 percent in 2007 before beginning its continuing shrinkage.)

The cause of reform, no matter how urgent, is not well served by the unilateral imposition of sudden and savage cuts in public services. Such indiscriminate cutting slashes demand — a counterproductive strategy, given huge unemployment and idle productive enterprises that have been decimated by the lack of market demand. In Greece, one of the countries left behind by productivity increases elsewhere, economic stimulation through monetary policy (currency devaluation) has been precluded by the existence of the European monetary union, while the fiscal package demanded by the Continent’s leaders is severely anti-growth. Economic output in the euro zone continued to decline in the fourth quarter of last year, and the outlook has been so grim that a recent report finding zero growth in the first quarter of this year was widely greeted as good news.

There is, in fact, plenty of historical evidence that the most effective way to cut deficits is to combine deficit reduction with rapid economic growth, which generates more revenue. The huge deficits after World War II largely disappeared with fast economic growth, and something similar happened during Bill Clinton’s presidency. The much praised reduction of the Swedish budget deficit from 1994 to 1998 occurred alongside fairly rapid growth. In contrast, European countries today are being asked to cut their deficits while remaining trapped in zero or negative economic growth.

There are surely lessons here from John Maynard Keynes, who understood that the state and the market are interdependent. But Keynes had little to say about social justice, including the political commitments with which Europe emerged after World War II. These led to the birth of the modern welfare state and national health services — not to support a market economy but to protect human well-being.

Though these social issues did not engage Keynes deeply, there is an old tradition in economics of combining efficient markets with the provision of public services that the market may not be able to deliver. As Adam Smith (often seen simplistically as the first guru of free-market economics) wrote in “The Wealth of Nations,” there are “two distinct objects” of an economy: “first, to provide a plentiful revenue or subsistence for the people, or, more properly, to enable them to provide such a revenue or subsistence for themselves; and secondly, to supply the state or commonwealth with a revenue sufficient for the public services.”

Perhaps the most troubling aspect of Europe’s current malaise is the replacement of democratic commitments by financial dictates — from leaders of the European Union and the European Central Bank, and indirectly from credit-rating agencies, whose judgments have been notoriously unsound. 

 

Participatory public discussion — the “government by discussion” expounded by democratic theorists like John Stuart Mill and Walter Bagehot — could have identified appropriate reforms over a reasonable span of time, without threatening the foundations of Europe’s system of social justice. In contrast, drastic cuts in public services with very little general discussion of their necessity, efficacy or balance have been revolting to a large section of the European population and have played into the hands of extremists on both ends of the political spectrum.

Europe cannot revive itself without addressing two areas of political legitimacy. First, Europe cannot hand itself over to the unilateral views — or good intentions — of experts without public reasoning and informed consent of its citizens. Given the transparent disdain for the public, it is no surprise that in election after election the public has shown its dissatisfaction by voting out incumbents.

Second, both democracy and the chance of creating good policy are undermined when ineffective and blatantly unjust policies are dictated by leaders. The obvious failure of the austerity mandates imposed so far has undermined not only public participation — a value in itself — but also the possibility of arriving at a sensible, and sensibly timed, solution.

This is a surely a far cry from the “united democratic Europe” that the pioneers of European unity sought.

Amartya Sen, a Nobel laureate and a professor of economics and philosophy at Harvard, is the author, most recently, of “The Idea of Justice.”