Last week’s short-lived threat of referendum by the Greek Prime Minister brought to the fore a real possibility of the break-up of the euro zone. Even today, although the referendum has officially been called off, no one is absolutely certain of the future of the euro zone.
While the possibility of the breakup of a major currency union looms large, it would be interesting to seek the historical evidence on the effects on macroeconomic variables of exits from currency unions.
Prof Andrew K. Rose, of Haas School of Business, Berkeley, CA has published a preliminary research paper titled, “Checking Out: Exits from Currency Unions”.
This 2006 paper starts by stating that “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.” This paper attempts to study the macroeconomic performance of the countries leaving currency unions to those who prefer to stay within a currency union.
This paper finds that “Countries leaving currency unions tend to be larger, richer, and more democratic; they also tend to experience somewhat higher inflation. Most strikingly, there is remarkably little macroeconomic volatility around the time of currency union dissolutions, and only a poor linkage between monetary and political independence. Indeed, aggregate macroeconomic features of the economy do a poor job in predicting currency union exits.”
The above evidence and the recent contrasting performance of Iceland versus Ireland, where a similar banking crisis had different results, due to the choices made by the respective societies, should be a good guide for politicians in all the euro zone countries, whether Greece or Germany.
Also, market participants should pay a great deal of attention to the last line of concluding remarks: “Indeed, aggregate macroeconomic features of the economy do a poor job in predicting currency union exits”. In other words, if the euro zone were to actually break up, the first deserters need not be the countries with the weakest fundamentals.