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The Future of the Euro: the Options for Finland

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The Future of the Euro: the Options for Finland A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Kanniainen, Vesa Article The Future of the Euro: The Options for Finland CESifo Forum Provided in Cooperation with: Ifo Institute – Leibniz Institute for Economic Research at the University of Munich Suggested Citation: Kanniainen, Vesa (2014) : The Future of the Euro: The Options for Finland, CESifo Forum, ISSN 2190-717X, ifo Institut - Leibniz-Institut für Wirtschaftsforschung an der Universität München, München, Vol. 15, Iss. 3, pp. 56-64 This Version is available at: http://hdl.handle.net/10419/166578 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle You are not to copy documents for public or commercial Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich purposes, to exhibit the documents publicly, to make them machen, vertreiben oder anderweitig nutzen. publicly available on the internet, or to distribute or otherwise use the documents in public. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, If the documents have been made available under an Open gelten abweichend von diesen Nutzungsbedingungen die in der dort Content Licence (especially Creative Commons Licences), you genannten Lizenz gewährten Nutzungsrechte. may exercise further usage rights as specified in the indicated licence. www.econstor.eu Special The think tank held that the foreseen political union THE FUTURE OF THE EURO: including the banking union and fiscal union will push THE OPTIONS FOR FINLAND the eurozone towards a sort of practical federal state, referred to as the ‘weak federation’. It has also tran- spired that conflicts of interest between individual 1 VESA KANNIAINEN member states cannot be overlooked in the assessment of the future evolution of the eurozone. States facing a sovereign debt crisis demand that their problems be Introduction resolved through solidarity, while member states that have put in a better performance in looking after their The European Monetary Union (EMU) was a political public finances object to joint liability. project from the outset. The uncertainty factors in- volved were disregarded, even though many econo- The report conveyed a message to Finland’s political mists, especially in the United States, warned of the decision makers: Finland has a range of options, in- risks involved. Unfortunately, their fears have become cluding the current ‘driftwood option’, a unilateral re- a reality. The EuroThinkTank of Finland, a working turn to the Maastricht Treaty (Maastricht 2.0) with an group representing consisting of economists, experi- option to abstain from a further step towards integra- enced professionals in the financial sector and a statis- tion, and Fixit, an immediate return to the national tician, undertook to analyse the underlying reasons for currency. the economic and political crisis afflicting the eurozone and to assess the future of the euro. The group special- ly focused on the options available to Finland, a small Why the euro crisis? euro member. The think-tank members were united by a sense of disappointment with the economic develop- The reasons behind the euro crisis have been extensive- ment of the eurozone, the rhetoric nature of the policy ly discussed by economists. The book authored by the on the euro and the lack of diversity in the argumenta- EuroThinkTank of Finland reviewed those reasons, tion related to the assessment of its performance. including labour market mechanisms and the resulting current account problems. Moreover, a lot of attention The report raised the following questions: was devoted to the financial issues, i.e. excess liquidity (i) Why is the eurozone in crisis? What is the mag- created in the eurozone. The purpose of the monetary nitude of the welfare losses the crisis has led to? union was to integrate the eurozone’s financial systems, (ii) Do the political union, banking union and fiscal improve their efficiency and to create favourable condi- union represent solutions that promote democ- tions for risk diversification. This did not materialise. racy, economic efficiency and the general wel- True enough, progress was made with integration, but fare and security of the eurozone’s citizens? cross-border financing contributed to debt bubbles. As (iii) Is a full-blown federation a better option than banks with distorted balance sheets became increas- the current trend towards a weak federal state, ingly dependent on short-term borrowing instead of or are we heading for the re-adoption of nation- traditional deposits, they also became more exposed to al currencies? disruptions. Most importantly, the debt markets were (iv) What are the options available for Finland? fuelled by cheap money, for which favourable condi- tions were created by the key central banks, the ECB 1 University of Helsinki. This article is based on a book published on 7 May 2014 by the Libera Foundation. To produce the book, the included. During the euro’s lifetime, the financing base Finnish EuroThinkTank worked in the facilities of the University of Helsinki and its members were Vesa Kanniainen (Chairman), Jukka of the banking sector crumbled and its size relative to Ala-Peijari, Elina Berghäll, Markus Kantor, Heikki Koskenkylä, Pia the production capacity of the eurozone grew out of Koskenoja, Elina Lepomäki, Tuomas Malinen, Ilkka Mellin, Sami Miettinen, Peter Nyberg and Stefan Törnqvist. proportion. Large banks became oversized banks. CESifo Forum 3/2014 (September) 56 Special Figure 1 and the ECB, which gave added Growth rate of money supply (M3) and lending by impetus to the growth of debt. financial institutions in the eurozone Annual% ANNUAL change CHANGE in % 14 Several handicaps have been iden- tified in the development of the 12 Privare sector loans EMU. The most fundamental 10 one, however, is of a political na- 8 ture. The leaders in the eurozone 6 did not show strict commitment (4.5%) to the jointly designed rules of 4 M3 economic policies. The economic 2 relations between the US Federal 0 Govern ment and the states, on –2 the contrary, have been governed by a strict no-bailout policy since –4 1992 1995 1998 2001 2004 2007 2010 2013 1840. The Fed does not hold Source: ECB. bonds issued by the states in its portfolio. The book took the view that to understand the crea- tion of excess liquidity, a closer examination of the ECB’s monetary policy is required. In many cases lax The welfare loss of the euro countries monetary policy often underlies credit expansion. The crisis originating in the United States in 2008 can be An argument can be put forward that the eurozone traced back to lax monetary policy coupled with failed would have tumbled into difficulties even without the housing market policy and, in particular, shadow shock originating in the United States. The book pro- banking operations. There were also regulatory fail- vides a statistical assessment of the potential size of the ures in the supervision of the markets and financial cumulative welfare loss incurred by the euro members. It institutions. The ECB’s monetary policy in the 2000s, is based on the evolution of the eurozone’s GDP relative the years leading up to the euro crisis, was also lax. to the recovery of a reference economy, the United According to the chart below, the M3 money supply in States. While the statistical link between real growth in the eurozone grew by 106 percent during 2001–2008, GDP in the United States and the EMU was extremely while the average annual growth rate should have re- strong up until the end of 2007, it has broken since then. mained at 4.5 percent according to the first pillar of The assessment was made using several statistical models the Maastricht Treaty. based on one-step forecasts. In a sense, the cumulative welfare loss measures the distance by which actual GDP In the 1990s, the monetary author- has fallen behind potential GDP. The idea is that the US ities on both sides of the Atlantic Figure 2 were perhaps thinking that the stance of monetary policy with Stochastic difference equation: cumulative prediction error GDP low interest rates is sound enough 5 as the rate of inflation is under 0 control. What this view fails to - 5 take into account is the fact that the rate of inflation was down be- - 10 cause of the globalization process - 15 based on low-cost production in - 20 the developing countries.­­ Under- - 25 lying the easy accumulation of - 30 debt was the evolution of the Eu- ropean bond market. Central to - 35 2008 2009 2010 2011 2012 2013 these developments were the ar- Source: Own calculation. rangements made by Eurobanks 57 CESifo Forum 3/2014 (September) Special GDP serves as a surrogate variable Figure 3 for a larger set of phenomena af- GDP per capita growth rates in UK, USA, Sweden and Finland in fecting GDP in the eurozone.2 terms of purchasing power parity, 1860–2008 % 10.5 3 The following models were used: 10.0 9.5 – Stochastic difference equation: 9.0 the actual evolution of the eu- rozone’s GDP was explained 8.5 by its built-in delay structure 8.0 Finland Sweden and the actual evolution of the 7.5 UK US GDP. 7.0 USA – VAR model: actual real GDPs 6.5 of the eurozone and the United 1860 1875 1890 1905 1920 1935 1950 1965 1980 19952010 States in inter-depend ency. Source: Bolt and van Zandern (2013). – VARX model: eurozone’s and Finland’s GDP were explained From 1999–2008, the real rate of growth in both by US GDP in addition to the built-in delay regions was 2.3 percent.
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