Monday, June 14, 2010

Leaving a Currency Union: They Did It

Is the departure from a currency union a most unusual move? Not really. Does it have to be a traumatic event, jeopardizing the economy? Not at all. That is what one can learn from a recent Andrew K. Rose paper « Checking out : Exits from Currency Unions » (Draft, December 15, 2006, published in the Journal of Financial Transformation, 2007).

Here is the abstract:

”This paper studies the characteristics of departure from monetary unions. During the post-war period, almost seventy distinct countries or territories have left a currency union, while over sixty have remained continuously in currency unions. I compare countries leaving a currency union to those remaining within them, and find that leavers tend to be larger, richer, and more democratic; they also tend to have higher inflation. However, there are no typically sharp macroeconomic movements before, during, or after exits.”

In fact his sample, the largest to date, includes 69 leavers, and 61 stayers. And, unsurprisingly, the countries that have been continuously members of a currency union during that period tend to be small, dependent ones, as confirmed by another study by Alesina and Barro (Alesina, Alberto and Robert J. Barro (2002) “Currency Unions”, Quarterly Journal of Economics, CXVII, 409-436).

I say “unsurprisingly” because one of the theoretical conditions for being a potential member of an optimal currency area (OCA) is to be a small country trading mainly with a large partner.

As Rose puts it:

“it is true that 24 currency union members are dependencies, such as Aruba, the Channel Islands, and Greenland. However, 37 independent countries have remained continuously in currency unions, including Cameroon, Luxembourg and Panama.” These are, I would say, also small countries dependent on large ones for their trade, one of the main conditions for entering an OCA.

A quick look at Rose’s list of continuous currency union members is quite revealing of the typical small size (and most likely concentrated trade) of these staying countries:

American Samoa; Antigua & Barbuda; Enin; Brunei Darussalam; Central African Republic; Cook Islands; Faeroe Islands; French Polynesia; Greenland; Guam; Kribati; Lichtenstein; Marshall Islands; Monaco; Nauru; Niue; San Marino; St. Kitts; Swaziland; Tuvalu; Wallis & Futuna.
Andorra; Aruba; Bermuda; Burkina Faso; Chad; Cote d’Ivoire; Falklands; Gabon; Grenada; Guernesey; Lesotho; Luxembourg; Martinique; Montserrat; New Caledonia; Palau; Senegal; St. Lucia; Togo; Virgin Islands.
Anguilla; Bahamas ; Bhutan; Cameroon; Congo; Dominica; French Guiana; Gibraltar; Guadeloupe; Jersey; Liberia; Isle of Man; Micronesia; Namibia; Niger; Panama; St.Helena; St.Vincent & Grens; Turks and Caicos Islands; Wake Islands.

Nothing indeed like France, Italy or Spain.

Regarding our second question, the possibly traumatic effect of leaving a union, an answer is also to be found in Rose’s study. He compares various macroeconomic variables of leavers three years before leaving and three years after leaving: GDP growth, inflation, government budgets, and so on.

His conclusion:

“perhaps the most striking feature of the data is the absence of volatility. In general, there are remarkably few signs of dramatic macroeconomic events either preceding or following currency union dissolutions.”(p. 7).

My conclusion: an exit of the southern members of the eurozone, including France, especially at the right exchange rate parity of the euro relative to the dollar as I explained in my Thursday post “Apocalypse No: Euro Exit Without Tears” , would most probably be painless.

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