Balancing the European Currency Union - an Impact Analysis on the Return of National Currencies

The current state budget crisis in the EU and the numerous futile efforts to solve the problem has brought back the fraction of people that argument in favour of an exit strategy of Germany from the ECU or even the break-up of the ECU in total. The path to the ECU was long and mainly politically driven. Albeit, the theory of optimal currency area (OCA) has favoured – prior to the establishment of the ECU – the European master plan, it seems to be now the right time to question, whether the benefits of the ECU still outweigh the negative implications resulting from the crisis. The aim of the paper is to estimate the comparative advantage / disadvantage of Germany’s membership in the ECU from a purely economic point of view. And thus, to investigate whether an exit-strategy should be pursuit or not. Three scenarios are calculated: (i) a baseline scenario (ii) Germany’s exit from the ECU (iii) worsening of the EU state budget crisis that cumulates in the rapture of the ECU.Macro-econometric models that are based on national accounts and input-output tables are especially useful for estimating such scenarios, as they are able to quantify direct and indirect effects on inter-industrial level as well as on the demand and supply sides of the economy. Above that, they do consider sectoral effects which are extremely important for the evaluation of the impact analysis. This paper uses the dynamic macro-econometric input-output model INFORGE which uses regression analysis to describe economic behaviour of different economic agents (consumers, producers, exporters, importers, investors). Inter-industrial relations are explicitly used and change over time. Accounting consistency is assured in all time; on the production side as well as on the demand side. The bottom-up approach is characterized by a high desaggregation on sectoral level, enabling a detailed modelling by industries and goods. The integrated structure of the model allows a complex and simultaneous solution due to the absolute accounting consistency. Input-output tables are fully implemented in the national accounts allowing linkages between inter-industrial interdependencies, distribution of income, the redistribution effects of the state and the usage of income for goods. Production is determined by the demand side of the economy via the Leontief-equation, all determinants of demand depend on relative prices which are again a function of firm’s unit costs and import prices. The model is extended by a trade module that allows differentiating Germany’s exports by 54 countries and 2 regions and, hence, estimating the trade effect of a total or partial break-up of the ECU. The inter-industry forecasting model for Germany – INFORGE – has been developed by the Institute of Economic Structures Research (GWS) and can be applied for economic forecasts as well as for simulation analysis. Such an economic experiment as pursuit in this paper requires strong assumptions. The results are thus to be seen in the light of these boundaries that are unfold in the paper. Especially, the assumption on the likely movement of interest rates, currency exchange rates, import prices, and the economic development of the rest of the world frames the modelling output. The quantitative results of the simulations on the economy are compared with a status-quo scenario. The expected computed results of the impact analysis are that Germany’s benefit of being a member of the ECU outweighs the negative implication taken from the crisis. The results are yet to be computed with the updated version of INFORGE 2011 but are to be expected to be finalized by March 2012.