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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):

Finland's stuttering recovery

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:

Three Finnish 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.

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?

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Economists are and were against the european currency union, its advantages are mainly political. The reasons for entering were mostly political. Whether - in the short run - the consequences outweigh the effects, sounds to me like speculation. Summa summarum, off topic. –  FooBar May 20 at 17:17
Economists are and were against the european currency union Well, that's a tough and really across-the-board statement. Reality is more subtle.. –  André Peseur May 20 at 19:29
I note FooBar said the advantages of European monetary union are "mainly political." There are some economic advantages. One example is that European multinational companies do not have to plan for fluctuations in exchange rates inside the eurozone. –  Marko Amnell May 20 at 21:08
@MarkoAmnell These benefits are smaller for larger firms, who could always hedge against these risks rather cost effectively. Anyhow, these benefits are rather second-order, once you compare them to the less of monetary authority. We diverge. Perhaps you are interested in posting this as a separate question, I can also refer you to my post here: economics.stackexchange.com/questions/4951/… –  FooBar May 21 at 0:04
@FooBar, I read your post and agree the countries of the European Union do not constitute an Optimum Currency Area (OCA). Barry Eichengreen presents evidence in favour of this conclusion in Chapter 3 of his book European Monetary Unification, where he writes: "I find that real exchange rates within the Community have been more variable than real exchange rates within the United States, typically by a factor of three to four." (p. 52) –  Marko Amnell May 21 at 0:50

1 Answer 1

The closest we can get to an answer would be by looking at previous exits from currency unions. Rose published a paper studying extensively all exits after WWII.

The abstract resumes well the conclusions of the paper:

This paper studies the characteristics of departures from monetary unions. During the post-war period, almost seventy distinct countries or territories have left a currency union, while over sixty have remained continuously in currency unions. I compare countries leaving currency unions to those remaining within them, and find that leavers tend to be larger, richer, and more democratic; they also tend to have higher inflation. However, there are typically no sharp macroeconomic movements before, during, or after exits

The effect denoted are very small, which leads me to conclude the choice should be made on political, not economical grounds, but everybody is free to have their own answer about this.

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Rose does not consider the Gold Standard and its effects in the 1930s. Eichengreen and Sachs show in "Exchange Rates and Economic Recovery in the 1930s" [Journal of Economic History, Vol. 45, No. 4, (Dec, 1985), pp. 925-946] that all countries which left the Gold Standard saw an increase in output. Rose notes that in the absence of an independent monetary policy, asymmetric shocks "can potentially be handled by fiscal policy." This option is ruled out for countries in the eurozone by the EU's Stability and Growth Pact which limits deficits to 3 percent and government debt to 60 percent of GDP. –  Marko Amnell May 21 at 16:27
@MarkoAmnell the Gold Standard is not a "currency union" as defined by Rose, and is not post WWII. He does ignore it because it doesn't fit in a framework that seems large enough to him to envision today's European union. You're free to work on such a study on the whole XXth century, I'm sure many would love to learn from conclusions from a significant number of examples. –  VicAche May 21 at 19:27
No, Rose explicitly says his study does not include the European Union. See Footnote 2 on page 2: "Parenthically, I note that 19 countries have entered currency unions post-war. This is too small a number to study sensibly with statistical techniques, especially given that a dozen of them are associated with EMU and thus highly dependent." His study only includes countries that have "continuously been members of currency unions" since World War II. Thus, the whole European Monetary Union project is excluded as countries entered it after World War II. –  Marko Amnell May 21 at 20:31
With respect to the Gold Standard, yes Rose only considers currency unions and excludes any other currency arrangements that fix exchange rates. He also excludes currency boards. Rose writes on page 2: "Hard fixes of exchange rates, such as those of Hong Kong, Estonia, or Denmark, do not qualify as currency unions, even if they are currency boards." The problem with these restrictions, and not looking at events during the 1930s, is that Rose excludes the very cases which do show a clear improvement in economic performance following an exit from some form of fixed exchange-rate system. –  Marko Amnell May 21 at 20:56
@MarkoAmnell "seems large enough to him to envision". I studied Rose paper, I know what he wrote. He is studying exit, so there is no reason for him to talk about European union. Luxembourg and Belgium where actually in a currency union before WWII already, but I agree it's a detail. –  VicAche May 21 at 21:38

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