Eurozone: Benefits And Threats Resulting From Joining The Common Currency Area Operating In Europe

The aim of this essay is to present the most important benefits and threats resulting from joining the common currency area operating in Europe. The analysis of financial as well as micro- and macroeconomic aspects allowed me to conclude that, despite its shortcomings that may be the cause of economic instability (as an example we can cite the occurrence of asymmetric shocks in some of the eurozone countries), the European currency functions within the optimum currency area that allows member countries to achieve various economic synergies.

An important aspect of my work is also pointing to the strategic dimension of this form of economic cooperation of the countries belonging to the euro area. In the following paragraphs of my work I would like to demonstrate that the common currency and monetary policy pursued by the European Central Bank are important determinants of the economic competitiveness of the European Union (despite the fact that not all of the EU member states belong to the eurozone). By allowing closer economic cooperation among member countries, it contributes to a stronger bargaining position of the European community on the international stage, while also improving the efficiency of individual countries in terms of international trade and capital movement within the community. These benefits in my opinion outweigh the costs and potential threats in the long run, but in the academic world the discussion about the optimality of the European Union as the common currency area still causes much controversy.

An economic Nobel laureate specializing in international trade research, Paul Krugman, has been arguing for years that the European Union is not an optimum currency area. In the case study ‘Is Europe an Optimum Currency Area?’ presented in 2009 by Krugman and Maurice Obstfeld, researchers present four criteria that they believe can determine whether a group of countries creates an optimum currency area .

1. Volume of trade within the region; according to economists, this factor is important, because a country interested in joining a monetary union can benefit more in a situation where its economy and the economy of the countries associated in the union are strongly connected economically. Krugman and Obstfeld pointed out that in 1999 internal trade between EU countries was between 10-20% of total trade in these countries, which was a smaller number than in the case of trade between regions of the United States.
2. High workforce mobility; after the creation of the European Union, a large part of the barriers related to the flow of goods, services and work was removed, but as Martina Fuerrutter states in her article ‘The Eurozone: An Optimal Currency Area?’, the free movement of labor is still at a lower level than in United States. It is influenced by cultural issues, and the problem itself concerns not only flows between countries, but also within them.
3. Economic structure of member countries; according to Krugman and Obstfeld, economic structure of member countries should be as close to each other as possible. As economists say, a similar production structure (range of produced goods), a similar level of employee qualifications or technological advancement have an impact on the optimality of the currency area. In their opinion, countries with similar production structure are able to better adapt to economic and currency shocks resulting from fluctuations in production levels. They point out the large differences between the ‘northern countries’ and ‘southern countries’ in terms of factors such as education and competences of employees, access to capital or modern production technologies. In their opinion, these differences determine the different needs of individual member states in the area of monetary policy.
4. The issue of fiscal federalism; according to Krugman and Obstfeld, an important element of maintaining economic balance within the optimal currency area is the possibility of coordinated fiscal policy. This option allows funding for those countries which, due to the macroeconomic imbalance resulting from fixed exchange rates, fall into serious financial problems (see: Greece during the 2012 debt crisis). However, transfers between countries are impossible in the absence of a common European budget – during the debt crisis that hit Greece and other southern European countries, the EU budget was only about 1% of EU countries’ GDP.

The arguments of Krugman and Obstfeld related to the alleged lack of optimality of the European Union as a common currency area were challenged by economist Waltraud Schelkle of the London School of Economics, who presented an important argument in the context of the European single currency area in a comment on her blog . She quotes the words of researcher and columnist Martin Sandbu, who stated that ‘policy choices, not any structural flaws of a common currency, are to blame for the euro area’s travails’ . Schelkle argues that economic threats related to the adoption of the single currency are inevitable, however, appropriate fiscal, regulatory or social policies would allow countries to minimize the risks associated with the negative effects of centrally implemented monetary policy.

The issue of discussion is, of course, how far the current economic policies are sufficient to overcome the coming crises. According to Schelkle, the US lesson is a valuable lesson in terms of development of common currency area. The economist refers primarily to the institutional order created in the United States and the role of the Federal Reserve as a lender of the last instance for states that are in a poor financial condition. She also emphasizes that interest rates are not a perfect tool for stabilizing the economy, as they concern financial markets in particular and have a limited impact on the real economy. The economist points out that it were regulatory and fiscal solutions developed over decades, not ‘greater optimality,’ that have made the United States a well-functioning common currency area.

Taking into account the current situation in the euro area and analyzing Europe as a common currency area allows us to draw conclusions about the benefits and threats of accession to the monetary union by these EU countries that, like Poland, have maintained their own currency so far. Countries analyzing the possibility of joining the euro area must bear in mind the need of meeting the four convergence criteria, related in turn to price stability, sustainable public finances, exchange rate stability and an appropriate level of long-term interest rates. According to the latest European Commission report for 2020, Poland as a country currently meets two of these criteria – the sustainability of public finances and the level of interest rates.

In Poland, there has been a discussion about the adoption of the euro for years. There is no doubt that in the case of the dynamically developing economy of a country, goal of which is economic convergence and gradual catching up with Western European countries in terms of living standards, arguments related to the subject of accession may be different than in the case of highly developed countries. In my opinion, however, the most important benefits of Poland joining the eurozone are in fact universal. The adoption of the single currency may become a stimulus for the development of trade exchange and a more dynamic flow of people, services and capital, and thus have an impact on the possibilities of facing development barriers, including middle income trap.

In the report ‘Should Poland Join the Euro? An Economic and Political Analysis’ published in 2016, analysts from the Woodrow Wilson School of Public & International Affairs’ at Princeton University consider the meaningfulness of Poland adopting the common currency. They put forward a number of political arguments. They refer to the concept of ‘two-speed Europe’ and the ‘seat-at-the-table’ approach, which can allow Poland to increase its influence on the political agenda of the European Union and open new opportunities for cooperation with partners within the community. Authors of the report recognize that Poland has solid macroeconomic grounds for adopting the single currency, what results from the well-functioning fiscal and regulatory policies. The authors note that in the period preceding the subprime crisis and the debt crisis in the eurozone, the country was not excessively indebted, and it allowed effective counter-cyclical fiscal policy that protected the country from economic recession.

Writing about the advantages of the euro as a common currency in an article published as a part of the CES Working Papers series ‘Euro – advantages and disadvantages’ , Romanian economist Gabriel Mursa raises the issue of reduced transaction costs associated with the exchange of national currencies inside the eurozone, which in his opinion foster economic specialization and strengthening of economic integration. In practice, trading in a common currency area is more profitable than trading outside it – member states are then able to make more profitable use of their comparative advantages by mitigating the threats associated with currency risk.

As a researcher associated with the heterodox Austrian school, he also draws attention to the fact that the euro area in some respects resembles the gold standard postulated by Austrian school economists, as it prevents the monetization of public debt by national central banks. The economist also mentions that the very fact of the existence of convergence criteria and the need to apply them in practice is an additional motivation for countries aspiring to being part of the eurozone to maintain fiscal balance and currency stability. At the same time, Mursa criticizes the actions of some countries which, in his opinion, use intentional currency devaluation as a tool for economic stimulation.

Another ‘free market’ argument for the introduction of the euro are benefits for consumers: price stability, which is often not offered by national currencies, as well as easier access to a wide range of products without the need for currency conversion. In addition, as the European Commission describes on its website, the introduction of the euro can affect not only the quality of individual consumption, but also investment, as it contributes to better integration of financial markets and the availability of new financial instruments for investors from countries joining eurozone. Shaping and developing of common, transnational markets of products and services will allow to strengthen the economic and political position of European Union countries. It has far-reaching strategic effects for all of the countries participating in such integration. This argument is particularly important in the face of economic tensions between the United States and China. Close integration involving currency issues can allow European countries to become one of the three main global political forces and, from a political perspective, an alternative to the nationalist policy of both powers.

The European Commission also mentions the ‘identity’ dimension of having its own European currency. It is worth paying attention to the huge impact of operating own currency and conducting a coherent monetary policy subordinated to own interests on the functioning of the aforementioned (China and the US) countries. While the dollar has been the main currency used for international settlements for decades, the role of the yuan is also growing – the currency has recently been included in the Special Drawing Rights basket by the International Monetary Fund, while the ‘panda bonds’ offered in many countries around the world are becoming increasingly popular.

Promoting own currency is in the interest of a country or group of countries that aspire to be a global power. It is therefore in the interest of the aforementioned Poland, as well as of other countries of the ‘new European Union’, to strengthen existing economic integration by adopting a common currency. The process of expanding eurozone will strengthen the bargaining position of European Union countries in the world, but also, what is important from the point of view of Poland or Czech Republic, will accelerate the process of economic convergence, encouraging entities from other European Union countries to direct their investments to these countries, and also facilitating further negotiations regarding European cohesion policies that allow to accelerate the modernization of less-developed parts of the countries.

One of the controversies related to the adoption of the euro by dynamically developing European countries may be the issue of the impossibility of conducting sovereign monetary policy after joining eurozone. This problem may be particularly visible in the case of Poland, where the possibility of conducting a monetary policy tailored to its own interests (e.g. purchase of currency swaps for Swiss francs) has significantly reduced the negative effects of the recent financial crisis. At the same time, euro area countries were struggling with problems, due to the differing levels of economic development and the macroeconomic situation, which differed their needs in terms of monetary policy. This problem also affected the Baltic countries, which joined the ERM II mechanism just before the crisis.

The occurrence of so-called asymmetric shocks, associated with the diversity of responses of individual economies to rapid macroeconomic changes, is an argument for staying with national currency. In my opinion, however, conducting a coherent, centralized monetary policy has one major advantage – it allows central bankers to give the right direction and scale of central bank intervention in times of crisis, while targeting those entities that are in the greatest need.

An example is the LTRO (Long-Term Refinancing Operations) asset purchase program run by the European Central Bank in the wake of the recent financial crisis . Although in practice the assumptions related to the increase in lending could not be realized, the banks received a liquidity cushion during a difficult period. In conditions of difficult macroeconomic situation in a given country or region, the European Central Bank has the possibility to introduce monetary policy instruments of a larger scale than in the case of national central banks. This argument may be important especially in the case of countries that have problems with the liquidity of financial institutions or the quality of loans granted.

The arguments for adopting the euro by countries considering such a decision which I have presented in the previous paragraphs relate, inter alia, to lower transaction costs, economic benefits resulting from the integration of financial markets, facilitation of the flow of services and capital between the member states of the monetary union as well as significant macroeconomic, geopolitical or image factors. In my opinion, these benefits are more significant than the existing macroeconomic threats and costs.

Referring to the opinion of Waltraud Schelkle, I think, moreover, that eurozone’s macroeconomic imperfections can be amortized by using appropriate fiscal and regulatory policy in the eurozone countries. According to many economists, modern monetary policy tools are not enough to combat a major crisis, such as the one resulting from the COVID-19 pandemic. Fiscal policy tools must be applied here, both for individual member states and using the federal budget (e.g. a postulated proposal to introduce universal basic income in European countries during current crisis). The introduction of the common currency may therefore not have a serious negative impact on the macroeconomic stability of the ‘new European Union’ countries, especially if these countries, as in the case of Poland, have been conducting effective fiscal and regulatory policy for years. At the same time, the microeconomic and political benefits for countries joining the euro area are, in my view, indisputable and very significant. For this reason, I believe that it is in the best interest of Poland and other European Union countries currently outside the eurozone to join it in the coming years.