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.

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?

  • 2
    $\begingroup$ 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. $\endgroup$ – FooBar May 20 '15 at 17:17
  • 3
    $\begingroup$ Economists are and were against the european currency union Well, that's a tough and really across-the-board statement. Reality is more subtle.. $\endgroup$ – user4239 May 20 '15 at 19:29
  • 4
    $\begingroup$ 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. $\endgroup$ – Marko Amnell May 20 '15 at 21:08
  • $\begingroup$ @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/… $\endgroup$ – FooBar May 21 '15 at 0:04
  • $\begingroup$ @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) $\endgroup$ – Marko Amnell May 21 '15 at 0:50

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.

  • $\begingroup$ 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. $\endgroup$ – Marko Amnell May 21 '15 at 16:27
  • $\begingroup$ @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. $\endgroup$ – VicAche May 21 '15 at 19:27
  • $\begingroup$ 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. $\endgroup$ – Marko Amnell May 21 '15 at 20:31
  • $\begingroup$ 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. $\endgroup$ – Marko Amnell May 21 '15 at 20:56
  • 1
    $\begingroup$ @MarkoAmnell I think you win a Godwin Point for this one, well done ;). I don't think any Euro-zone instance ever advocated for an openly deflationist policy, which hopefully makes Euro-zone not-quite-as-insane as Brüning's government... If you could post a separate answer to advocate your views on Euro-zone, I would greatly appreciate reading it, but I think we're done with not-commenting on this answer ;) $\endgroup$ – VicAche May 24 '15 at 9:55

(I guess a long answer can be fitting to a long question...)

The current state of knowledge as to "how to run a socioeconomic area (SEA)" could be grossly summarized as follows:
There is a Government that has the right to collect taxes and conducts fiscal policy, in order to provide some public goods, and also to partially smooth economic inequality through redistribution (not because we are good and humanitarian people, but so as not for the inequality to eventually threaten the SEA's existence).
There is the area's fiat money, backed by the Government's sovereignty.
There is a Central Bank that makes loans to the Government, so as for monetary policy to be a "negotiated outcome" between the Government and the Central Bank, attempting to partly offset the short-horizon that politicians are forced (or like) to have. The Central Bank has also the role of "lender of last resort" for the commercial banks, so as to secure the stability of the fiat money system.

If a SEA-wide shock hits, and an economic recession or crisis sets in, monetary policy can be used in what is in effect a "reverse-causation" scheme: instead of first producing and then creating the money in order to match this new production for exchange purposes, we first create the fiat money, that now functions as windfall-wealth, in order to increase demand and thus generate new production that will eventually match the money (that's what "demand side policy" is all about). If the economy is in a recession, and there is a large amount of unemployed factors of production, it has some good chances of succeeding (i.e. the increased demand will activate again factors of production rather than just create inflation). Note that the use of fiscal policy in such a situation essentially amounts to the same thing -but instead of strengthening the demand of the private sector towards the private sector, it is the government that directly, through fiscal policy, purposefully raises aggregate demand in order to induce supply.

If an asymmetric shock hits selectively only some parts of the SEA, then the government can use its tax revenues for (usually geographic, but also sectoral) redistributive purposes, channeling resources to the regions/sectors that are hit. Moreover, if factors of production are mobile enough, they will move towards the comparatively more economically healthy regions/sectors, alleviating the problem of production factors' unemployment, which if it persists, will create a social problem, and will threaten the SEA's cohesion.

Now consider the European Union: It has a currency alright, and a Central Bank -but the Central Bank is not permitted to act as a lender of last resort proper -the currently observed "quantitative easing" is a silently accepted bending (not breaking) of the official rules of the ECB. Why deprive the European Central Bank of such a fundamental function of a central bank? Because it was Germany's non-negotiable condition in order to create a common currency, originating from Germany's experience with hyperinflation. Germany did not impose this to others, having made an exception for itself: when there was still a Deutsche mark, Germany's central bank also was not permitted to act as a lender of last resort for the commercial banks (and Germany's economy proved strong enough to not ever come in need of such a safety valve).

The EU also has a "Government" (the European Commission) -but its fiscal budget is so small compared to the EU's economy, that it cannot adequately perform any redistributive function to the required degree, in the case of an asymmetric shock (redistribution happens alright -but it is slow and long-term). Also, members' national budgets are under scrutiny and hard-pressed at a political level in order not to go south.

Finally, due to history and culture, factors of production, especially human ones, have very low mobility.

So while a SEA-wide shock is not really likely for such a diverse area like the EU, asymmetric shocks are much more likely for the very same reasons -and it is for these asymmetric shocks that the EU is really lacking the tools to deal with, at least the tools that are currently known and used.

Therefore, it appears that we have to concede that the European Union, including monetary union, was a "premature" action, if judged by macroeconomic criteria: on the balance, the tangible economic benefits appear to be outweighed by the hardships introduced. Theoretically, we should have first wait for economic homogeneity and integration to happen or nearly-happen, and then strengthen it through the creation of the EU. And indeed, this was the original plan: the European Union started as partial (country-wise and sector-wise) economic semi-unions here and there, to slowly and gradually help economic integration -and then it accelerated, because the global geopolitical situation suddenly changed and (deep) uncertainty once more ruled the land...

...We should make a mental effort to imagine what the experience of two devastating World Wars (which are not that old, anyway), has imprinted on this continent. The forced/hurried economic unity/integration represented by the EU, was and still is in my opinion mainly an attempt to lay these continent-wide nightmares to rest. Since this is a "negative" motive, it is only natural that "positive" motives emerged in the process.

Especially after the crisis of 2008, one could argue with some strength that currently, the European Union is little more than "feeling asphyxiated, but sticking together, grinding our teeth"...

...So, perhaps "everyone should exit"?

The real issue as I see it is whether the alternative will be eventually along the lines of (economically and/or physically) "sharpening our teeth to each others' neck" -or not.

  • $\begingroup$ Your statement that the EU is "little more than 'feeling asphyxiated, but sticking together, grinding our teeth'" is similar to the view of Luigi Guiso, Paola Sapienza, and Luigi Zingales in "Monnet's Error?" who say: "Europe seems trapped in catch-22: there is no desire to go backward, no interest in going forward, but it is economically unsustainable to stay still." But Greece may soon "go backward" and leave the euro. In Finland, one centrist politician, Paavo Väyrynen, has recently said that if Greece leaves the euro (Grexit), Finland should also give up the euro (which he calls "Fixit"). $\endgroup$ – Marko Amnell Jul 1 '15 at 15:26
  • $\begingroup$ @MarkoAmnell Certainly I do not claim any unexpected originality in my answer, the weaknesses of the EU, especially in the face of economic crises are by now extensively discussed. Clever slogans like "Fix-it" are certainly entertaining to the intellect, and I am glad clever politicians exist in some country. My worries with breaking up the Union, (and it is usually done piece-by-piece), lie in the long-term. And if Economics have taught me one thing, is that more often than not, the short-run interests and desires conflict with the long-run ones. $\endgroup$ – Alecos Papadopoulos Jul 1 '15 at 15:39
  • $\begingroup$ The article "Monnet's Error?" is available at: brookings.edu/about/projects/bpea/papers/2014/monnets-error The authors note, inter alia, that the contradictions in the European integration project that you describe in your answer are part of Monnet's grand functionalist plan (ridiculed as "outdated functionalist sociology" by Bernard Connolly in The Rotten Heart of Europe). Guiso et al. write: "The functionalist view, advanced by Jean Monnet, assumes that moving some policy functions to the supranational level will create pressure for more integration $\endgroup$ – Marko Amnell Jul 1 '15 at 15:58
  • $\begingroup$ (continued): through both positive feedback loops (as voters realize the benefits of integrating some functions and will want to integrate more) and negative ones (as partial integration leads to inconsistencies that force further integration). In the functionalists’ view integration is the result of a democratic process, but the product of an enlightened elite’s effort. In its desire to push forward the European agenda, this élite accept to make unsustainable integration steps, in the hope that future crises will force further integration." (p. 3) $\endgroup$ – Marko Amnell Jul 1 '15 at 16:06

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.