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An Optimum Currency Crisis

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  • Paolo Pasimeni

Abstract

This paper presents an ex-post assessment of the current situation of the EMU in light of the conditions prescribed by the theory of Optimum Currency Areas (OCA). The analysis shows that some of those conditions were satisfied at the inception of the EMU, others were missing at the beginning, but improved over time as expected by the endogenous approach to the OCA theory. The common fiscal capacity was the main missing element of the initial construction of the Eurozone, and still is. The common budget is so exiguous that its effectiveness as shock absorption mechanism is negligible. The analysis then shows how some of the concerns raised on the eve of the euro did actually materialize, even if not immediately. First, in its first decade the Eurozone did not experience major turbulences, because growing financial integration was compensating the need for fiscal transfers, channelling the excess of saving from the ‘core’ to the ‘periphery’. Second, the mechanism generated record-high private indebtedness in the ‘periphery’ and exposure of the banks in the ‘core’, making the whole system more fragile as it relied upon financial markets’ stability. Third, once the long-feared shock hit, the mechanism proved weak and non-resilient. The inherent weaknesses of the EMU became evident. Fourth, as it had been foreseen, the cost of the adjustment after the shock fell mainly on labour, with much higher and longer unemployment in the Eurozone than both non-Eurozone EU and the US. Fifth, as the theory suggested, the lack of common mechanisms of adjustment dramatically increased the socio-economic divergences within the EMU. The paper finally presents a simulation for a common budget of the Eurozone, linked to the relative current account positions of the member states.

Suggested Citation

  • Paolo Pasimeni, 2014. "An Optimum Currency Crisis," European Journal of Comparative Economics, Cattaneo University (LIUC), vol. 11(2), pages 173-204, December.
  • Handle: RePEc:liu:liucej:v:11:y:2014:i:2:p:173-204
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    2. João Sousa Andrade & António Portugal Duarte, 2015. "Optimum Currency Areas, Real and Nominal Convergence in the European Union," Notas Económicas, Faculty of Economics, University of Coimbra, issue 42, pages 8-29, December.
    3. Giovanni Covi, 2020. "Euro area growth differentials: diverging and reinforcing factors in a Kaleckian SVAR approach," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 47(1), pages 147-180, February.
    4. Mogaji, Peter Kehinde, 2015. "Review of Architectural Flaws of the EMU: What Eurozone Crisis Lessons for the Proposed ‘Afrozone’?," MPRA Paper 99334, University Library of Munich, Germany.
    5. László Andor, 2016. "Towards shared unemployment insurance in the euro area," IZA Journal of European Labor Studies, Springer;Forschungsinstitut zur Zukunft der Arbeit GmbH (IZA), vol. 5(1), pages 1-15, December.
    6. Apergis, Emmanuel & Apergis, Iraklis & Apergis, Nicholas, 2019. "A new macro stress testing approach for financial realignment in the Eurozone," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 61(C), pages 52-80.
    7. Francesco Spadafora, 2019. "European integration in the time of mistrust," Questioni di Economia e Finanza (Occasional Papers) 512, Bank of Italy, Economic Research and International Relations Area.

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    More about this item

    Keywords

    EMU; Optimum Currency Areas; Socio-economic Divergences; Fiscal Union; Political Union;
    All these keywords.

    JEL classification:

    • B22 - Schools of Economic Thought and Methodology - - History of Economic Thought since 1925 - - - Macroeconomics
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • F15 - International Economics - - Trade - - - Economic Integration
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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