During the run-up to the monetary union, many economists were sceptical and warned that it would not work. Their argument was simple. Europe was not an optimal monetary union because it lacked both labour mobility and the fiscal mutual insurance schemes that exist in the US. Also, nominal price formation was rigid so that we could not expect it to offset imbalances and competitiveness differences quickly. Despite those shortcomings, the sceptics considered that the costs of monetary union were not too large after all, because asymmetric shocks are not that important quantitatively.
The Eurozone was formed and it was largely accepted as an irreversible fact. The sceptics refrained from questioning its soundness as an institution for fear of being perceived as unrealistic or extreme. Mentioning that a member country might leave the monetary union some day was considered a political non-starter, so that pragmatic economists who insisted on making a difference in the policy arena did not see the point in ruining their credibility by making such suggestions.
With the Greek crisis, we are brutally reminded that such a prospect is far more real than it was assumed. In order to keep Greece in the Eurozone, other countries must foot the bill, while imposing harsh conditions that – in my view – will be fulfilled only hypothetically. So why do we want to keep Greece in the Eurozone, especially given that membership plays no small role in its current troubles?
Asymmetric trends not asymmetric shocks
The reason why the Eurozone does not work is not asymmetric shocks – their cost is constant over time and therefore unlikely to lead to the single currency's eventual demise – but asymmetric trends. Over the last decade, countries in the Eurozone have quietly but stubbornly diverged in terms of inflation, growth, fiscal performance and competitiveness.
* Some have had 2% inflation on average, others 4%.
* Some have built up trade surpluses, others are increasingly indebted with respect to the rest of the world.
* Some have kept their government budget in check, others have let debt grow.
This divergence comes from different policy choices, different institutions, and different cultures. But the common currency, contrary to the hopes of those who believed such a straightjacket would force member countries to converge in real terms, has in fact added to the divergence.