The present state of the monetary union is not very attractive. It is therefore quite natural to ask if it is still worthwhile for a country like Hungary to join such a monetary union.
The causes of the crisis are common to the global economy, although local policy errors and design deficiencies contributed to shaping the crisis in the Economic and Monetary Union (EMU). These are the so-called “imbalances.” Modern, stability-oriented macroeconomic policies, together with cheap imports from low-cost producer countries, helped achieve low inflation and stable growth and market players felt increasingly confident. This resulted in the increasing indebtedness of households and certain sectors dependent on credit, such as construction or consumer durables, and asset price bubbles. The subprime crisis of 2007, followed by the collapse of a major US bank in 2008, resulted in heightened uncertainty, with global financial markets frozen for nearly everybody, and resulted in large drop in trade and incomes.
Interestingly, the EMU as a whole had smaller public deficit and debt ratios than the US. Moreover, the EMU had about a balanced external position vis-à-vis the rest of the world, while the US had a significant balance of payment deficit. Why, then, did the crisis hit the EMU harder than the US?
The answer is that deficits and debts were very unevenly distributed among the participating countries. As the EMU is a unique monetary union not backed by a sufficient degree of fiscal integration, markets started to question the capacities of the indebted participating countries’ budgets to support their overstretched banks and indebted households. The support needed to restore confidence had been delayed due to its political unpopularity with constituents, thus markets started to panic.
The EMU institutions were designed to prevent other types of imbalances: excessive public deficit, debt and inflation. However, with the exception of Greece, public spending had not been excessively profligate. The erosion of competitiveness, like in Portugal or Italy, was much more a result of excessive wage moderation in other EMU participants and import competition from low-cost, third-world producers than of excessive inflation. Common monetary policy is certainly pro-cyclical to an extent, as has been emphasized in an earlier post on this blog, but even this could never result in such a crisis without the markets overlooking fundamental differences among the participating countries and excessive confidence in general.
The crisis resulted from new challenges, the development of internal and external balances, like balance of payments deficits and excessive credit growth. This is the reason why countries like the UK or the US also face crisis, despite their monetary autonomy. They accepted the argument that “this time is different”.
To avoid repeating such risks, the European Commission and the European Central Bank proposed a set of reforms, including an Excessive Imbalance Procedure to complement the reinforced fiscal coordination, as well as establishing a European Systemic Risk Board to overlook macroprudential risks. Finally, a new permanent crisis resolution facility, the European Stability Mechanism, will be established to manage a future crisis in case all the above mechanisms should fail. Together with the more careful behavior of market participants, these reforms may give some assurances to avoid the crisis of the EMU periphery in the future. This remains true even if one has to acknowledge that some decisions were delayed and some reform proposals are too much tilted towards budgetary policies and labor cost competitiveness, due to parochial political considerations.
Some believe that a weak exchange rate could help the Hungarian economy out of the hole and support growth. In my view, the exchange rate is best helpful in a short-term adjustment, but only if not offset by foreign exchange liabilities, and not overused. On the flipside, it is not a well behaving tool under the control of the central bank. It can itself be a source of serious shocks as well. The EMU could provide a shelter from such shocks. The new coordination mechanisms give additional tools to cope with the risks of imbalances, while still leaving enough room for national preferences in responsible policy making.
Our geographic location and traditional linkages to the core of Europe give us a chance to closely integrate with the most active core of the integration, securing a dynamic future income convergence, a chance that is much less provided for the peripheral EMU participants. This was, and remains the original rationale for Hungary to join the EU. Joining monetary union helps in stepping up integration.
Zoltán Szalai is a senior economist at the National Bank of Hungary (MNB). The views expressed in this piece are those of the author and do not necessarily represent official positions of the MNB.