Sankalp Wagh, Vice President
The speculation whether Greece will leave the Eurozone has gripped the entire World. The media has even created the term 'Grexit' for it. Even as solutions for ending this mess are being actively pursued, the financial crisis in Greece still worsens continuously and puts other member states of the Eurozone at risk of being drawn in similar crises. It's not just Greece that has been unable to pay its debt back; other Eurozone countries like Ireland, Portugal, Spain and Cyprus have also faced troubles repaying their debts without the assistance of third parties like IMF and ECB . If these countries are unable to pay their debt, it would have a huge impact on the world economy and some argue that it would resemble the recession of 2008 (or be much worse!). All this leads one to wonder whether forming Currency Unions, like the Eurozone, is a good idea.
Normally when a country is faced with a debt crisis it starts devaluing its money (increasing money supply, which is part of country's monetary policy). This makes the loans that are denominated in its currency easier to repay. But that is not an option for countries that are a part of a monetary union. In a monetary union, the monetary policy of a member nation is controlled by a multi-national Central Bank but the fiscal policy (how much money they can spend and where they spend it) is controlled by the country's government. Now some member countries may be experiencing growth and may not want to devalue the common currency while some countries may want to devalue. But the Central Bank may not devalue or devalue only by a very small percentage. This may hurt countries which are facing debt repayment problems.
Without the power of controlling the money supply, troubled countries may be forced to adopt austerity measures which aim at reducing budget deficits i.e. make expenditure smaller than revenue. Austerity measure may include spending cuts or tax increases or both. These generally increase unemployment as government spending falls, reducing jobs in the public and private sector or both. Tax increases reduce household disposable income and thus consumption. Even though this results in the reduction of debt, the GDP of the nation is also hurt and the country goes into a deep recession, thus creating a vicious cycle
The situation in EU is worsened by another factor: lack of labour mobility. Now Currency Unions are a great idea for countries which have similar economic performances, similar cultures and same language which makes the labour mobile. If the labour is not mobile, it may lead to pockets of areas which are depressed and people cannot find work and areas where economy flourishes and wages increase (Just like Greece and Germany in the EU). Now, because the labour market is not mobile unemployment in depressed countries rises and decreases its GDP and tax revenue. This greatly affects that countries ability to manage its finances and repay its debt.
But these situations can also be avoided easily by strict adherence to a set of rules. Monetary unions have certain criteria (Maastricht criteria for the EU) that must be fulfilled by the member nations before being integrated into the union. These criteria put a ceiling to the permissible values of inflation, deficit and debt of the member country. This ensures that member countries don't let their debts increase to abnormally high values.
Now, no matter what the economic conditions in a country are at the present, they may face problems like recession in the future. If they are a part of a Monetary Union they cannot devalue to boost exports like China did by devaluing Yuan. They may also be unable to borrow more to boost jobs or cut taxes to make themselves more attractive because of the debt and budget deficit criterion set by the Monetary Union.
This article tries to highlight the problems with Monetary Unions but this is only one side of the coin.
The speculation whether Greece will leave the Eurozone has gripped the entire World. The media has even created the term 'Grexit' for it. Even as solutions for ending this mess are being actively pursued, the financial crisis in Greece still worsens continuously and puts other member states of the Eurozone at risk of being drawn in similar crises. It's not just Greece that has been unable to pay its debt back; other Eurozone countries like Ireland, Portugal, Spain and Cyprus have also faced troubles repaying their debts without the assistance of third parties like IMF and ECB . If these countries are unable to pay their debt, it would have a huge impact on the world economy and some argue that it would resemble the recession of 2008 (or be much worse!). All this leads one to wonder whether forming Currency Unions, like the Eurozone, is a good idea.
Normally when a country is faced with a debt crisis it starts devaluing its money (increasing money supply, which is part of country's monetary policy). This makes the loans that are denominated in its currency easier to repay. But that is not an option for countries that are a part of a monetary union. In a monetary union, the monetary policy of a member nation is controlled by a multi-national Central Bank but the fiscal policy (how much money they can spend and where they spend it) is controlled by the country's government. Now some member countries may be experiencing growth and may not want to devalue the common currency while some countries may want to devalue. But the Central Bank may not devalue or devalue only by a very small percentage. This may hurt countries which are facing debt repayment problems.
Without the power of controlling the money supply, troubled countries may be forced to adopt austerity measures which aim at reducing budget deficits i.e. make expenditure smaller than revenue. Austerity measure may include spending cuts or tax increases or both. These generally increase unemployment as government spending falls, reducing jobs in the public and private sector or both. Tax increases reduce household disposable income and thus consumption. Even though this results in the reduction of debt, the GDP of the nation is also hurt and the country goes into a deep recession, thus creating a vicious cycle
The situation in EU is worsened by another factor: lack of labour mobility. Now Currency Unions are a great idea for countries which have similar economic performances, similar cultures and same language which makes the labour mobile. If the labour is not mobile, it may lead to pockets of areas which are depressed and people cannot find work and areas where economy flourishes and wages increase (Just like Greece and Germany in the EU). Now, because the labour market is not mobile unemployment in depressed countries rises and decreases its GDP and tax revenue. This greatly affects that countries ability to manage its finances and repay its debt.
But these situations can also be avoided easily by strict adherence to a set of rules. Monetary unions have certain criteria (Maastricht criteria for the EU) that must be fulfilled by the member nations before being integrated into the union. These criteria put a ceiling to the permissible values of inflation, deficit and debt of the member country. This ensures that member countries don't let their debts increase to abnormally high values.
Now, no matter what the economic conditions in a country are at the present, they may face problems like recession in the future. If they are a part of a Monetary Union they cannot devalue to boost exports like China did by devaluing Yuan. They may also be unable to borrow more to boost jobs or cut taxes to make themselves more attractive because of the debt and budget deficit criterion set by the Monetary Union.
This article tries to highlight the problems with Monetary Unions but this is only one side of the coin.