05 February 2008

In Response to CITIZEN OF EUROPE: Do Central - Eastern European countries need their own Gordon Browns?

Jan Jablonski clashes with Citizen of Europe. The first blog debate starts!

The text makes two major points. Firstly, the fact that the UK stays outside the Eurozone allows it to make a necessary economic adjustment through currency depreciation rather than through “painful disinflation”. Secondly, as an opposite case, Spain didn’t have a freedom in altering the exchange rate, therefore the adjustment had to be done through prices and consequently affect employment. It actually all boils down to the question about whether it pays to join the Eurozone, as giving up the currency and monetary policy is the essence of a monetary union.

The discussion on this topic is already humongous starting from “the optimum currency area theory”. For the case of the UK the famous Five Economic Tests for assessing the UK's readiness to join the Eurozone can be mentioned. On the course of the discussion however, it does not become clear whether floating exchange rate regime helps dealing with shocks and adjustments or is in fact an another source of a shock. Additionally, Spain did not enjoy the benefits of having semi-world currency as the UK does (which brings substantial income), so giving up peseta was easier in that sense. Here:

“In Spain, the booming economy led to rising wages and, as a result, to a surging inflation. That in turn contributed to the loss of exports competitiveness and economic slowdown.”

The discussion is actually about business cycle. The supposition is that a proper monetary policy response would be the appropriate action. However, was a monetary policy in Spain an efficient tool in smoothing business cycle before joining the Eurozone? Maybe it was not? Maybe fiscal policy is actually a more efficient tool? Of course it is efficient only in case of a proper budget discipline, giving space for the automatic stabilizers to work.

Even if adopting euro was not really helpful to deal with the situation in Spain, is it also the case for EEC? The article is not really clear about how to relate the UK and Spanish example to the EEC, but certainly the first question to ask would be about business cycle synchronization. How much are the cycles of EEC synchronized with their biggest EU trading partners. Is it to the similar extent as in Spain? In case it is more synchronized, giving up monetary policy for European Central Bank would be less painful for the EEC than it was for Spain.

Author: Jan Jablonski, MSc, Economics International moderator

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