HOW STABLE IS THE EURO?

A. G. MalliarisLoyola University Chicago

Society for Policy Modeling at the ASSA Annual Meetings

Chicago, Illinois, January 6 - 8, 2012

KEY QUESTIONS FOR DISCUSSION

• Will the Euro Survive the Recent Crisis?• Is the Euro Still a Good Idea for the EU?• Is there a Sufficient Political Commitment to

Preserve the Euro? • What Are the Choices of the Weak EMU

Countries?

BROADER QUESTIONS

• What is the Role of the Euro in the Global Monetary System?

• How is the U.S. Impacted from the Euro? Other Countries such as China?

• What is the Role of the Euro in Terms of Global Imbalances?

• What Are the Most likely Scenarios About the Euro and the Global Economy?

HOW TO APPROACH THESE QUESTIONS?

• Few Methodological Choices• Review Recent History• Economics of Optimum Currency Area• Global Financial Crisis of 2007-09• Persistent Global Financial Imbalances• Use the Concept of STABILITY

How to Proceed?

• How Stable is the Euro?• Stability as a Unifying Theme• But “What is Stability?”• An Economic System is Stable if it Recovers

After an Internal or External Shock.• Recovers Means Return to Potential GDP • Claim: The Euro is Stable• Challenge: How Stable??

Proposed Methodology

• Examine and Evaluate the Shock

• Assess the Impact of the Shock on the Stability of the Euro

Examine the Shock

• The Global Financial Crisis of 2007-09• Declines in Real GDP• Increases in Government Expenditures• Greece, Ireland, Portugal, Spain, Italy

Experience Large Public Deficits and Debts• Banks Face Significant Risks from Holding

Sovereign Debt

Evaluating the Shock

• Impact on the Euro: Remains Stable

• Impact on EU Growth: Weak but not Dismal

• Banks Remain Stable

• Most Pain Experienced by Greece, Ireland, Portugal

First Arguments for Stability

• The Euro as a Currency Remains Stable; No Evidence of Imminent Collapse

Second Argument for Stability

• The EMU Economy Remains Stable

• EMU GDP is about 20% of Global Economy

• 2012 EMU GDP to Grow at about 0.5% to -0.2%

• 2013 EMU GDP Expected to Resume 1% to 2% Growth

Third Argument for Stability

• Robust Global Growth of 3.5% Will Help the EU

• A Weak Euro Will Help Also Exports

• Additional Easing Expected by the ECB

Fourth Argument for Stability

• Additional Easing Expected by the ECB

• Bank Deleveraging is Going Well and May End by 2012

• Excellent Corporate Balance Sheets

Fifth Argument for Stability

• Solid Past Record on Growth

• Solid Record on Low Inflation

• Low Interest Rates

• PARADOX: Past Success May Have Contributed to Excessive Sovereign Borrowing

Sixth Argument for Stability

• Despite Political Complexities There Is Sufficient Political Will to Stabilize the Euro

• Dramatic Success of Political Developments in Greece and Italy (Papademos and Monti Governments of Technocrats)

• Long History of Political Initiatives for Over 50 Years Towards Establishing the EMU

Seventh Argument for Stability

• Core Germany and France are Stable• Serious Imbalances for Greece, Ireland,

Portugal• Options to Leave the Euro Are not Attractive• The Euro Commands a 25% Share of Global

Reserves; Second to US Dollar with 60%• British Pound is 4% and Japanese Yen is also

about 4%

Counter-Arguments

• Long History of Financial Crises• Financial Markets Often Fail to Estimate

Correctly Risks• Financial Institutions Often Fail to Manage

Risks Effectively• The Euro Compounded Both by Promoting

Fixed Interest Rates and Exchange Rates• ECB Should Re-Address Financial Stability

Possible Future Scenarios

• Have Argued In Support of Stability of the Euro with Gradual Return to Normality in 2-3 Years

• If Rescue Plans Fail, Uncertainty May Contribute to Further Instability

• What If Some Countries Choose to Default and Leave the EMU?

• Total Collapse of the Euro?

ANSWERS TO QUESTIONS

• Is the Euro Still a Good Idea for the EU? YES.• Will the Euro Survive the Recent Crisis? MOST LIKELY;

CLOSER FISCAL COOPERATION IS NEEDED.• What Has Caused the Recent Euro Crisis? THE GLOBAL

CRISIS AND SUCCESS OF THE EURO.• Is there a Sufficient Political Commitment to Preserve

the Euro? MOST LIKELY; AREA OF UNCERTAINTY DUE TO COMPLEX INSTITUTIONS

• What Are the Choices of the Weak EMU Countries? VERY DIFFICULT

FURTHER ANSWERS• What is the Role of the Euro in the Global Monetary System? USEFUL

DIVERSIFICATION TOOL.

• How is the U.S. Impacted from the Euro? Other Countries such as China? MOSTLY POSITIVELY.

• What is the Role of the Euro in terms of Global Imbalances? THE EURO HAS BEEN MORE FLEXIBLE THAN THE YEN OR YUAN AND CONTRIBUTED TO A MODERATION OF GLOBAL IMBALANCES.

• What Are the Most likely Scenarios about the Euro and the Global Economy? EURO SURVIVES (95%); IF NOT, THE WORLD WILL EXPERIENCE A GLOBAL FINANCIAL CHAOS AND A SERIOUS ECONOMIC DOWNTURN.