Transcript | 4. lecture: The Euro and eurozone - University for modern Slovakia

The common European currency was established as a common accounting currency on 1.1.1999 while notes and coins began to circulate in the twelve founding countries of the euro area from the beginning of 2002. Today there are 17 members of the eurozone and the euro is the second strongest world currency and the second most widely used reserve currency. It is used by more than 300 million Europeans, except seventeen official member countries it is also used in the other six - Andorra, Monaco, San Marino, Vatican City, Montenegro, and Kosovo. In addition, 23 other states and territories have their currencies pegged at a fixed rate to the euro.

It follows from the above that the euro has become the second most important world currency after the dollar. Prior to outbreak of the global financial and economic crisis in the years 2008 - 2009 euro worked quite successfully and expanded and the voices of critics and sceptics were drowned out with this successful development. Today things have changed - as we mentioned in our previous lectures, the global financial and economic crisis, debt crisis came and with it came the crisis of the euro and the euro area.

First, let us say what are advantages and disadvantages of the common currency.
Among the advantages it is especially the higher exchange rate stability, and lower so called transaction costs. The stability of the exchange rate is mainly due to strength of the euro as the second strongest currency in the world. Especially for small and open economy such as Slovak, it is an important factor. Previously, the Slovak crown moved in both directions, without possibility to influence it with our economic policies what in the economy with a large share of foreign trade (up 170% of GDP) means high cost. Transaction costs in turn mean that the companies, people, and banks pay no fees for payment transfers from one currency to another. Analyses of NBS and the Ministry of Finance indicated that the positive effects of Slovakia joining the euro area mean higher economic growth by about 0.8% to 1% per year.

Every coin has two sides, of course. The costs and risks include, in particular the overall sustainability of the project, respectively costs associated with its maintenance and also the loss of opportunities for balancing by changing currency exchange rates.

Already upon creation of the euro in 1999, one of the most influential economists of the twentieth century, Nobel laureate Milton Friedman, proclaimed the euro will not survive the first major European recession and gave the euro ten years of life. Among the well-known, influential and very outspoken critics of the single currency belongs also Czech President Vaclav Klaus. The common denominator of critics is that the euro is more political than an economic project and that for common currency to work well, certain conditions must be complied with, which according to critics of the euro are not fulfilled.

Theoretical prerequisites for functioning of the single currency were formulated in his theory of optimum currency areas by Professor Robert Mundell, who received the Nobel Prize for his work in this area in 1999. According to this theory, the single currency can work well if it complies with the functioning of "optimum currency area". It is characterized with the following assumptions:

1. high degree of mobility of production factors (labour and capital)
2. high degree of business cycle synchronization
3. symmetry of the exogenous shocks and responses to them
4. high degree of diversification of foreign trade and homogeneous production structure
5. duplex flexibility of prices and wages
6. common fiscal policy, or fiscal transfers

These assumptions are in principle accepted both by critics and defenders of the euro. The difference is that while critics claimed, arguing that in the euro area, these criteria are not met and without major changes and costs cannot be met, the defenders have argued that they are fulfilled or that they tend to be fulfilled so that it does not jeopardize the future of the euro area.

Since the outbreak of euro crisis in spring of 2010 also the supporters of euro admitted that we had a problem and that the criteria and rules of optimum currency area were not sufficient, or they were not sufficiently complied with and enforced.

The analysis of economic development in the euro area since its inception, really shows that there are problems in meeting any one of the above prerequisites and probably the biggest problem is lack of flexibility of prices and wages (also downwards), lack of mobility of factors of production (especially labour). Reality also confirmed the words of those economists who argued that the single currency without a fiscal union leads to fiscal irresponsibility. Greece, but also other countries are clear example.

The fundamental problem seems to be also the fact that the single fiscal policy would require large transfers from richer and more prosperous members of the monetary union to poorer and more depressed. A typical example of a fiscal union was unification of Germany, with huge transfers from the western part in favour of East.

The creators of the common currency have been aware of the risks, therefore so called Maastricht criteria and the Stability and Growth Pact were adopted. These treaties set the rules and boundaries for responsible economic policies of countries aspiring to join the euro area and also those that had joined the monetary union already - the limits of deficit growth, public debt, inflation and interest rates, the rules for mandatory reduction of excessive deficits and the like. Today's reality shows that a major problem was not lack of rules, but their non-compliance and circumvention. Most cogently it is illustrated by the fact that the Maastricht deficit and debt criteria that each country had to meet before entering the euro zone today is respected by the minimum of the countries that are in the euro area already. With the debt criterion (public debt lower than 60% of GDP) comply Luxembourg, Finland, Slovenia, Slovakia and Estonia and with the deficit criterion (less than 3% of GDP) only Luxembourg and Estonia.

The key question therefore is under what conditions the euro area is sustainable, what is needed to make and change for the euro not only to survive, but also to be successful and strong currency. We'll talk about that in the last lecture of current trimester; meanwhile, we will have a closer look at the crisis in the euro area and the situation in Greece and Ireland.