Wednesday, July 29, 2009

The Future of the Euro (Part VII)

Speaking of optimal currency areas, Barry Eichengreen has a new article on whether some Euro countries may abandon the currency union:
Although housing prices have fallen euro area wide, they have fallen more dramatically in some countries than others. Although the crisis has meant large losses for banks throughout the euro area—often on those same housing-related investments—it has produced larger losses in some countries than others. It has led to rising unemployment throughout the euro area, but more in some countries than others. The result is more deflationary pressure, actual or potential, in some euro area countries than others. There are also more strains on the public finances of some euro area countries, as reflected in the widening of spreads on sovereign bonds and their associated credit default swaps.

Under these circumstances, different euro area countries presumably would prefer a different monetary policy response. But the members of the euro area are necessarily subject to a one-size-fits-all policy, such being the intrinsic nature of monetary union. This tension has revived the pre-1999 debate over whether monetary union in Europe is a good idea. It has also given rise to chatter and speculation about the possibility that one or more euro area countries might now choose to abandon the euro. This article weighs the implications of such a move and, although finding it risky, costly, and complicated, concludes that it is not inconceivable.
Read the rest of the article here. Here is the intrade contract on whether "any country currently using the Euro to announce their intention to drop it on/before 31 Dec 2010." (Click on figure to enlarge.)

This figure indicates the probability is only about 15% now, a big drop from the 40% high last year.


  1. Can individual European Central Banks purchase their own government bonds denominated in Euros? Also the closely watched German/Italian 10 year bond spread has been steadily declining since the beginning of the year - please comment.

  2. I believe the various national central banks buy and sell securities from financial institutions, not direct from their governments. Those securities might be government bonds or private sector bonds, such as mortgage backed securities