An Optimum Currency Crisis

This paper presents an ex-post assessment of the current situation of the EMU in light of the conditions prescribed by the theory of Optimum Currency Areas (OCA). The analysis shows that some of those conditions were satisfied at the inception of the EMU, others were missing at the beginning, but improved over time as expected by the endogenous approach to the OCA theory. The common fiscal capacity was the main missing element of the initial construction of the Eurozone, and still is. The common budget is so exiguous that its effectiveness as shock absorption mechanism is negligible. The analysis then shows how some of the concerns raised on the eve of the euro did actually materialize, even if not immediately. First, in its first decade the Eurozone did not experience major turbulences, because growing financial integration was compensating the need for fiscal transfers, channelling the excess of saving from the ‘core’ to the ‘periphery’. Second, the mechanism generated record-high private indebtedness in the ‘periphery’ and exposure of the banks in the ‘core’, making the whole system more fragile as it relied upon financial markets’ stability. Third, once the long-feared shock hit, the mechanism proved weak and non-resilient. The inherent weaknesses of the EMU became evident. Fourth, as it had been foreseen, the cost of the adjustment after the shock fell mainly on labour, with much higher and longer unemployment in the Eurozone than both non-Eurozone EU and the US. Fifth, as the theory suggested, the lack of common mechanisms of adjustment dramatically increased the socio-economic divergences within the EMU. The paper finally presents a simulation for a common budget of the Eurozone, linked to the relative current account positions of the member states.