ECB working paper: Weak states can be cut loose

We found an ECB Legal Working Paper entitled “Withdrawal and Expulsion from the EU and EMU.” It was released during the relatively quiet month of December around Christmas time.

There are some in-depth discussions on legal and political implications that a withdrawal or expulsion of a member from the EU would entail, but something that caught my eye in the paper was on page 41 in the discussion on “implications of a member’s withdrawal or expulsion for its euro area participation”:

“Whilst a Member State’s exit from the EU would, therefore, entail its exit from the euro area, this does not necessarily mean that the euro could no longer circulate in its territory. Indeed, a distinction should be made between a Member State’s euro area participation, in an institutional sense, and the circulation of the euro in its territory. Institutionally, a former Member State’s [National Central Bank] could no longer form part of the euro area (i.e. it could not participate in the governance structure and decision-making bodies of the [European System of Central Banks), at least not without an amendment to the [European Commission] Treaty and the Statute of the [European System of Central Banks].”

So if weaker states are to withdraw or be expelled from the EU, it can still have the euro circulate for domestic currency, but will not be able to participate in the governance structure of the ESCB. This is a good thing overall for the EMU as weak states are booted and will have no influence over ESCB and hence euro policy. It also strengthens the EMU in the sense that the ECB will be free of the liability to bail-out these governments – the market will be left with the decision – and it won’t be the euro that bears the brunt of bad policy. Furthermore, in the absence of a new currency being created by the government of the withdrawn/expelled state - its citizens will have monetary freedom to use any currencies they choose. It will limit the power of government over monetary affairs, and hence, reduce the ability of fiscal deficits that were the problem in the first place.

According to the paper, the possibility of continuing to use the euro is more ‘controversial’ and goes back to the debate on ‘euroisation.’  The circulation of euros before accession to the EU is called ‘euroisation’ – the 2-year primer to formal adoption of the euro. From page 42:

“There are two distinct ‘euroisation’ possibilities, the unilateral and the consensual one…

As for the unilateral adoption of the euro by third countries (as a former Member State would be after its exit from the EU and EMU) there does not appear to be a clearly formulated Commission position, despite the fact that there are several examples of third countries or entities which, even though not having the status of acceding countries, have unilaterally adopted the euro…

The ECB’s position on unilateral euroisation is summarised in the following statement: ‘the ECB … would neither encourage nor facilitate such a move. Countries which unilaterally introduce the euro would do so in their responsibility and at their own risk, without committing the EU or the ECB. The ECB would thus pursue a policy of non-engagement and non-support towards these countries’
(J. Stark, ‘The adoption of the euro: principles, procedures and criteria’, Speech delivered to the Icelandic Chamber of Commerce, Reykjavik, 13 February 2008, available here.)

Judging by the latter statement, unilaterally introducing the euro doesn’t seem all that ’controversial’ to us. Clearly any state or international organisation (such as Monaco, San Marino and the Vatican at present) can adopt the euro, but must not expect any support from the EU or the ECB. Perhaps the founding fathers of the euro anticipated the possibility of present conditions and wanted to avoid being in the same position as the US government which will have to bail out all of its bankrupt states - something that could require infinite printing of the US dollar. While the US government is bailing out its states, the EU and ECB can cut the weak states loose. This strengthens our conviction that the euro is fundamentally sounder on a long-term basis than its US dollar counterpart.

Withdrawal and expulsion from the EU and EMU