The euro: helping to shape the future of Europe

19 Sep 17

At his annual state of the European Union speech last week, Jean-Claude Juncker said all countries in the EU should adopt the euro.  The currency should “unite rather than divide”, the European president said. 

Here Panicos Demetriades, former governor of the Central Bank of Cyprus, tells us why he agrees. 

Economists remain sceptical about the euro. 

In a recent survey of leading European economists run by the Centre for Macroeconomics and CEPR, although the majority agreed that the euro had more benefits than costs,  over three quarters disagreed with the European Commission President’s suggestion that joining the euro should be compulsory for all EU member states.  

I belonged to the small minority - less than 10% - of economists that strongly agreed.  In this short article I explain why.

To start with, let me say that I understand why the majority of my colleagues in the CFM survey are negative about the proposal that the euro should be compulsory for all EU member states.  

There is no doubt that the euro area is not an optimal currency area, even as it stands, let alone if it is broadened. 

Countries that belong to the euro area are too diverse and are subject to different shocks.  A common monetary policy can only respond to common shocks. 

If shocks are not common, monetary policy is unable to deal with them.  

We teach our students that unless labour markets are perfectly flexible and/or there are automatic fiscal transfers to protect countries that experience negative real shocks, joining a monetary union when member states are subject to divergent shocks will create more costs than benefits.  

As neither of these conditions holds in the case of the euro area, why would anyone, in their right mind, support adopting the euro for even more countries?

My main point is that Europe and the euro have never been about counting pennies and pounds in a static or backward-looking sense. 

Europe is - and has always been - a political project, a project that will help shape the future of Europe.  First and foremost it was - and remains - a project of peace. 

The European Coal and Steel Community - the precursor of today’s European Union - was Europe’s answer to two very costly World Wars: it was explicitly set up to “make war not only unthinkable but materially impossible”.

Many economists certainly take peace for granted when they carry out their cost and benefit calculations.  But can we really take peace for granted?  

Does it take much more than a small historical accident for war to eventually break out again? 

What if, once again, nationalist movements come to power in key European countries such as France or Germany?  Scary thought. 

But not totally implausible.  What if there had been a different outcome in last May’s election in France?

The second fallacy in any cost-benefit analysis of the euro is that it is based on past facts (although it selectively ignores important events such as wars).  In so doing, it implicitly assumes that Europe - as a political project - is static.  

Yet, it only takes a quick read of president Juncker’s state of the union address to understand that Europe is anything but static. 

His vision of a Europe that protects, empowers and defends is nothing less than inspiring. It is a vision that further embeds democratic institutions, freedom, equality and the strength of the rule of law in nearly the entire continent.

The proposal to create a Euro-accession instrument to facilitate euro membership through technical and financial assistance can be a game-changer in terms of economic costs and benefits.

The suggestion to encourage all members states to join the Banking Union - a project that was only conceived in 2012 that I had the privilege to contribute to in its early stages - is another game-changer.

On top of that, there is the proposal to create a European ministry of economy and finance.  

The ministry’s remit will be to promote structural reforms in member states and to coordinate all EU financial instruments that can be deployed when a member state is hit by a crisis. 

This is a small but important first step towards fiscal federalism.  It can be the answer to differential shocks that the current euro architecture does not provide. 

Moreover, further integration will no doubt lessen the asymmetries across countries.  Shocks themselves will become less diverse and more common. 

Fifty years from now, Europe could already be looking like the United States of America, but only if we start implementing the vision as a whole. 

Cherry picking of whatever kind, including euro membership, can only create further fragmentation - not a United Europe.

Critics will no doubt argue that Juncker’s vision is nothing more than a vague set of ideas or that any moves towards greater risk-sharing in Europe are likely to be blocked by countries like Germany.

My own experience as a policy-maker in Europe suggests otherwise.  The Banking Union project is a case in point: in its initial stages few economists thought that this was anything more than a vague vision and even fewer thought it could be implemented so quickly. 

And, having witnessed at close range the euro crisis from the inside during 2012-13, I have no doubt as to the sheer determination, energy, enthusiasm and commitment of European policy-makers to do whatever it takes to safeguard the European dream, in which the euro is an indispensable part.  

  • Panicos Demetriades
    Panicos Demetriades

    former governor of the Central Bank of Cyprus and member of the governing council of the European Central Bank. Currently professor of financial economics at the University of Leicester and author of A Diary of the Euro Crisis in Cyprus: Lessons for Bank Recovery and Resolution.

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