Finland's economic recovery from the shock of the global financial crisis of 2007-8 has been very weak. The country has been in recession for the past three years, with GDP expected to expand by only 0.8 percent this year. See Chart 1 below (Source: Mehreen Khan, "How sleepy Finland could tear apart the euro project," The Telegraph, April 18, 2015):
Before Finland adopted the Euro, the common European currency, it faced two severe recessions (or depressions) during its years of independence after 1917. The first was the Great Depression of the 1930s and the second was during the early 1990s (the causes of which included the collapse of the Soviet Union in 1991 and a banking crisis in the Nordic countries).
As Lars Christensen, Danske Bank's chief analyst, has pointed out in his blog, Finland recovered from its economic downturns in the 1930s and the early 1990s, at least partially as a result of devaluing its currency, the Markka. Finland gave up the gold standard in October 1931, which was followed by a very strong economic recovery. Similarly, during the early 1990s, Finland followed a "strong Markka" policy of high interest rates, tying the Markka's exchange rate to the ECU currency basket (in the lead up to the launch of the Euro in 1999). This policy was abandoned in September 1992, allowing the Markka to float freely and devalue, which was followed by a strong economic recovery. See Chart 2 (Source: Lars Christensen, "Great, Greater, Greatest -- Three Finnish Depressions", November 16, 2014) below, which compares the performance of the Finnish economy during three depressions:
As can be seen from Chart 2, the tight monetary policy of the ECB in the years following the 2007-8 global financial crisis has been accompanied by a very weak recovery in the Finnish economy. In fact, as Christensen notes, the ECB's interest rate hikes in 2011 were followed by a contraction in the Finnish economy after some initial recovery.
The evidence strongly suggests that Finland needs to devalue its currency to recover from serious recessions. Devaluations boost the country's important export sector, including the forest products industry. As a member of the eurozone, Finland cannot devalue its currency and its monetary policy is set by the European Central Bank.
These problems were foreseen in the 1990s by economists and commentators, with Bernard Connolly's book The Rotten Heart of Europe: The Dirty War for Europe's Money being among the most vociferous criticisms. Connolly was fired by the European Commission for criticizing the European Exchange Rate Mechanism, which he used to help run. He saw the Euro as primarily a political project, not an economic one, part of the French and German project of ever-greater political integration in Europe.
As Connolly and others warned before the launch of the Euro, small countries situated on the periphery of Europe with economies whose structures differed from Germany and France, would suffer from asymmetric shocks that could not be appropriately dealt with as the small countries would lack an independent monetary and exchange-rate policy. The Finnish economy, for example, relies to a great extent on exports for economic growth. An asymmetric shock is a situation in which a shock to supply or demand differs from one geographic region to another, or when such shocks do not change in tandem.
The classic arguments in favour of flexible exchange rates are made by Milton Friedman in "The Case for Flexible Exchange Rates," (in Essays in Positive Economics, The University of Chicago Press, 1953, pp. 157-203) and Robert Mundell in "A Theory of Optimum Currency Areas" [The American Economic Review, Vol. 51, No. 4 (September, 1961), pp. 657-665]. However, later in his career, Robert Mundell offered an argument in favour of a shared European currency.
Should Finland leave the eurozone and return to its old national currency, the Markka? In light of my comments, obviously my strong suggestion is that it should, but leaving the eurozone would undoubtedly have various negative consequences, both for Finland and the European Union. Would these negative consequences outweigh the positive effects?