Alogoskoufis George and Jacque Laurent, Journal of Applied Corporate Finance, (Fall 2020), Volume 32, Number 4, pp. 90-104
The dream of building a unified Europe traces its roots back to the signing of the Treaty of Rome in 1957. France, Germany, Italy, the Netherlands, Belgium, and Luxembourg established a common market known as the European Community, or EC, which meant abolishing intra-trade barriers and erecting common external tariff barriers. To facilitate the functioning of the common market and encourage intra-EC trade and investment, exchange rate stability was deemed an integral part of deeper economic, financial, and political integration among EC member states. In the heyday of the Bretton Woods system (1944–1971), pegged exchange rates provided the necessary currency stability that made a monetary union a less urgent goal for the European project.
The breakdown of the Bretton Woods system in 1971 and the ensuing chaotic experiment of generalized floating exchange rates revived the goal of a European Monetary Union. The ill- fated European Monetary System (1979-99) re-enacted on a European scale a mini-Bretton Woods system of pegged exchange rates that was designed to limit exchange rate vola- tility. Undermining this quest for exchange rate stability were structural disparities, or “asymmetries,” between “core” and “periphery” countries. More specifically, the source of failure was the significant differences between member countries’ key macro-economic aggregates such as GDP per capita, unemployment, inflation, current account balances, interest rates, nominal and real exchange rates, fiscal balances, and government debt—differences that the European Monetary System proved unable either to elimi- nate, or to deal with effectively.
The launch of the single currency in 1999 rekindled the European Union’s momentum for deeper integration. But a first decade of low interest rates was marred by bulging budget- ary and current account deficits in several eurozone sovereigns that brought them to the brink of default in 2010. A second decade of sluggish and lopsided recovery since then has deeply scarred Europe’s social fabric and widened the divide between the single currency’s winners—Northern European countries—and losers—chiefly, the Mediterranean countries. Can a retrospective of the EU’s long quest for monetary union explain how the euro crisis was seeded? What is in store for the euro in its 20th year? Will the corona virus pandemic prove to be a game-changer by enabling the eurozone to recapture its momentum—or is it fated to languish and fade away?
In what we have cast as a drama in five acts, Act I recounts the quest for a European Monetary Union and documents the gradual deepening of monetary cooperation among member states. The promise of how the single currency held first with the launch of the euro in 1999 (Act II) but was later broken by the euro crisis (Act III) is explained through the lens of the construct of an optimal currency area. Is the euro @ 20 (Act IV) likely to limp along by “muddling through”? or, will the corona pandemic (Act V) usher the euro area into bold reforms to deepen the European monetary union by laying the foundations of a fiscal union? or will it simply splinter with one of the crisis countries exiting the euro area?