The Euro – A Monetary Strangulation Mechanism

In my previous post I claimed that the ‘Greek crisis’ essentially is not about Greece, but rather that the crisis is a symptom of a bigger problem namely the euro itself.

Furthermore, I claimed that had it not been for the euro we would not have had to have massive bailouts of countries and we would not have been in a seven years of recession in the euro zone and unemployment would have been (much) lower if we had had floating exchange rates in across Europe instead of what we could call the Monetary Strangulation Mechanism (MSM).

It is of course impossible to say how the world would have looked had we had floating exchange rates instead of the MSM. However, luckily not all countries in Europe have joined the euro and the economic performance of these countries might give us a hint about how things could have been if we had never introduced the euro.

So I have looked at the growth performance of the euro countries as well as on the European countries, which have had floating (or quasi-floating) exchange rates to compare ‘peggers’ with ‘floaters’.

My sample is the euro countries and the countries with fixed exchange rates against the euro (Bulgaria and Denmark) and countries with floating exchange rates in the EU – the UK, Sweden, Poland, Hungary, the Czech Republic and Romania. Furthermore, I have included Switzerland as well as the EEA countriesNorway and Iceland (all with floating exchange rates). Finally I have included Greece’s neighbour Turkey, which also has a floating exchange rate.

In all 31 European countries – all very different. Some countries are political dysfunctional and struggling with corruption (for example Romania or Turkey), while others are normally seen as relatively efficient economies with well-functioning labour and product markets and strong external balance and sound public finances like Denmark, Finland and the Netherland.

Overall we can differentiate between two groups of countries – euro countries and euro peggers (the ‘red countries’) and the countries with more or less floating exchange rates (the ‘green countries’).

The graph below shows the growth performance for these two groups of European countries in the period from 2007 (the year prior to the crisis hit) to 2015.

floaters peggers RGDP20072015 A

The difference is striking – among the 21 euro countries (including the two euro peggers) nearly half (10) of the countries today have lower real GDP levels than in 2007, while all of the floaters today have higher real GDP levels than in 2007.

Even Iceland, which had a major banking collapse in 2008 and the always politically dysfunctionally and highly indebted Hungary (both with floating exchange rates) have outgrown the majority of euro countries (and euro peggers).

In fact these two countries – the two slowest growing floaters – have outgrown the Netherlands, Denmark and Finland – countries which are always seen as examples of reform-oriented countries with über prudent policies and strong external balances and healthy public finances.

If we look at a simple median of the growth rates of real GDP from 2007 until 2015 the floaters have significantly outgrown the euro countries by a factor of five (7.9% versus 1.5%). Even if we disregard the three fastest floaters (Turkey, Romania and Poland) the floaters still massively outperform the euro countries (6.5% versus 1.5%).

The crisis would have long been over had the euro not been introduced  

To me there can be no doubt – the massive growth outperformance for floaters relative to the euro countries is no coincidence. The euro has been a Monetary Strangulation Mechanism and had we not had the euro the crisis in Europe would likely long ago have been over. In fact the crisis is essentially over for most of the ‘floaters’.

We can debate why the euro has been such a growth killing machine – and I will look closer into that in coming posts – but there is no doubt that the crisis in Europe today has been caused by the euro itself rather than the mismanagement of individual economies.

PS I am not claiming the structural factors are not important and I do not claim that all of the floaters have had great monetary policies. The only thing I claim is the the main factor for the underperformance of the euro countries is the euro itself.

PPS one could argue that the German ‘D-mark’ is freely floating and all other euro countries essentially are pegged to the ‘D-mark’ and that this is the reason for Germany’s significant growth outperformance relative to most of the other euro countries.

Update: With this post I have tried to demonstrate that the euro does not allow nominal adjustments for individual euro countries and asymmetrical shocks therefore will have negative effects. I am not making an argument about the long-term growth outlook for individual euro countries and I am not arguing that the euro zone forever will be doomed to low growth. The focus is on how the euro area has coped with the 2008 shock and the the aftermath. However, some have asked how my graph would look if you go back to 2000. Tim Lee has done the work for me – and you will see it doesn’t make much of a difference to the overall results. See here.

Update II: The euro is not only a Monetary Strangulation Mechanism, but also a Fiscal Strangulation Mechanism.


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  1. Tom Brown

     /  July 14, 2015

    Lars, a very interesting post. Thanks.

  2. Reblogged this on Money or Debt.

  3. Really good analysis Lars. Just one minor thing to add. The crisis hit eastern Europe in the fall of 2008. Thus for Romania only in the first quarter of 2015 did real GDP achieve the maximum it achieved at the end of 2008. If NBR would have allowed the currency to fluctuate freely, now it is a tightly managed float, than Romania would have recovered much faster. So, yes I do back up your view.

  4. Stavros Hadjiyiannis

     /  July 14, 2015

    Excellent statistics.

    Would be even more interesting to have the per capita GDP figures as well. Some countries have had significant population growth in the period under consideration. Also, debt figures would be extremely helpful for our analysis.

  5. Lars what about Corruption, debt, or a combinations of both, with or without the Euro o alternatively pegged countries? I think what you are suggesting that, for instance, Greece’s crisis would have been solved outside the Eurozone? IF that is the case, why they do not do it? Get outside the Euro for few years and return to it after healing. Looking carefully to the graphic I got the feeling that what you have found is more a spurious correlation, than a sound relationship between growth and the exchange rate/monetary system. I do not like the “if” conditional, it could take me to an artificial scenery. What about if you correlate public debt and economic growth, both in per capita terms? You would have got different picture, and different answers to a same problems to highly indebted countries.

    • Mads

       /  July 15, 2015

      That’s the expression I was looking for: ‘spurious correlation’. This is not scientifically sound, when you consider so few relatives. Surely, the countries’ relation to the Euro cannot be the only factor to consider. But a critical look at the EEC is always desirable.

  6. David Chipping

     /  July 14, 2015

    This is an objective view of the situation, I maintain that the rot had already been introduced when the euro was launched, as a result of the huge retail, overnight price hike in Southern economies on changeover to the euro. Coupled with a dramatic shift in industrial production to Far Eastern economies, the Southern states never found a firm footing.

  7. David Chipping

     /  July 14, 2015

    Alexguerreroe-I would sayit is too late for Greece to recover in normal terms , they should have exited the euro five years ago, but European
    hubris would not allow it. The Troika has critically damaged the economy and a debt deflation spiral has taken hold ;there is no easy solution.

  8. Dear Lars,

    I enjoy reading your often provocative pieces but when I want to comment, i need a wordpress account. Is that common?

    Also, imo your comparison between non EUR countries and EUR/peg ones is rather cheeky: suggestive but why not started at the start of the EUR and why not added a comparison in some kind of common currency or on a PPP basis. I think the EUR is a marvelous integrative tool and it will force change in a way only civil wars can. If you believe that the softer members in the club need to be bullied into acceptable levels of resilience, or leave the club, this is a good way to do it. It worked for East Germany and it will work for Greece. It would even work for Ukraine..

    Of course monetarists deal with the cycle, not with growth and the EUR is part of a grand project aiming at creating a superstate. That said MM would have been a better ECB approach than the half hearted application of German benign neglect for countercyclical monetary policy, if one ignores the need for fiscal discipline, But disobedient Greece (especially in the presence of compliant Ireland) presented a not to be missed opportunity to do as the Chinese say: kill the (Greek) chicken to scare the (latin) Monkey.. So I guess the Germans made a move. It may work out and Europe will integrate (into Germany) faster, or we have another German historical turning point where overreach is followed by collapse. Stalingrad or 1870. Bismarck or Schicklgruber, Frau Sauer’s choice. Interesting!

    Anyway, could you let me know how I comment (maye in a more restrained fashion) without WordPress?

    Cheers, Rien Huizer

    M.C. Huizer

    Kortegracht 7K 3811KG Amersfoort Netherlands +31 33 2852590


    Ericaweg 9/63 8072PV Nunspeet Netherlands

    Mob +31651013128

    • Rien, I think it should be working now.

      You say the euro a great integration mechanism. Well, to me it is a growth killing machine, which has INCREASE political disunity to an rather extreme degree. In would love not like to be a German tourists in Spain or Greece these days.

      Forcing a depression a country like Greece is not something that helps reforms. Rather it leads to the rise of extremist parties such as Syriza and Golden Dawn.

      In the 1930s monetary strangulation led to the rise of the nazi party. We all know the catastrophic consequences of that. I would not like something like that to happen again.

      Change cannot be forced on a country from abroad – unless you want full-scale colonization. Of course if the ask the man in the street in Athens today they will say that this is exactly what is happening and I wouldn’t necessarily disagree.

      By the way I disagree that Eastern Germany has worked out especially well. Monetary unionification probably was unavoidable, but the Bundesbank’s reaction to it was catastrophic. Today the Bundesbank is pushing for the same kind of policies in Europe as it was pushing in German in the first years follow re-unification. That is depressing.

  9. jamesxinxlondon

     /  July 14, 2015

    The continued rejection of the Drachma by the Greek people is the strange thing. It is a genuine fear of their own uselessness at running a currency, fear of their politicians, but also the fear of inflation. This inflation bogeyman permeates the world, from the head of Fed to the Greek pensioner and is the fear that really needs to be faced down. The amount of the fear tells you NGDP targeting has a very long educational road ahead.

    • kri

       /  July 22, 2015

      Um…no, the introduction of a currency takes time and has to be planned. It took over a year for the Americans to attempt to do it in Iraq and still forgeries, counterfeiting and chaos ensued.

      It takes time and money to print notes and have a central bank in place and notes of the old currency have to be printed as a stopgap measure .

      • jamesxinxlondon

         /  July 22, 2015

        If the ECB stopped accepting Euros in Greek banks as Euros, de facto Greece would be out of the Euro, and be in a world of Greek Euros, or Greuros. It would be overnight. The Euro notes and coins in curculation in Greece are irrelevant as they are only about 5-10% if broad money. The Greek central bank could easily “print” Greuros electronically by expanding its balance sheet by fiat. It is does it now via the ELA but needs the approval of the ECB for those new Euros to be considered real Euros.

  10. You lay the blame at the wrong door: The potential disadvantages of a common currency (just like the advantages) are well-known and discussed even in fairly basic texts on economics. However, the problem here is not the common currency—it is the too high tempo of expansion. The countries that have had the worst problems (Greece, in particular) are the ones that should not have been admitted at all. Greece even needed forged statistics to get in…

    If the monetary union had started with Germany, the Benelux, and possibly France or Austria (certainly the UK, had they been interested), to then expand with several countries per decade, things would have been very different.

    (Even France is arguably too weak to be in the first round, but it would be politically hard to exclude the French and the added market and econmic power would likely have outweiged the risk, especially in the absense of the Brits.)

  11. Great graph. Have used in my online review of Bernard Connolly’s book, which I read because you recommended it.

  12. Jazi Zilber

     /  July 15, 2015

    What will happen if we use data of 2001-2015?

    This will be the full period of Euro. Also, there was an Euro specific issue between 2010-2013

  13. Shouldn’t you start the analysis a bit farther back?

    If peggers outperform floaters during the boom years, they could (economically speaking) get far enough ahead that their lag during the bust years winds up with them still being ahead, even with a lagging recovery.

    (On the other hand, one can make the case that recovery from busts is more important than maximizing booms)

    Either way, I’m not certain you’re making the full case without looking at both boom and bust years.

  14. Dave

     /  July 16, 2015

    Is it naughty to say I love your German PPS?

  15. talldave2

     /  July 16, 2015

    Great post.

    Mark Sadowski makes a critical point at TMI: 2008-9 was when monetary policy had the largest impact — as MMs have been patiently explaining for a long time, that’s the time when NGDPLT looks very different than IT.

    Poland is a great example of how maintaining smoother NGDP growth maximizes RGDP. Maybe we should start maintaining some permanent lists of empirical evidence like this and also making some concrete predictions…

    • Tom Brown

       /  July 16, 2015

      “and also making some concrete predictions” …. YES!… falsifiable predictions. That’s pretty much the only reliable way to start to know anything about objective reality.

  16. Great piece Lars and I’m in full agreement with it. I especially appreciate this:

    “Change cannot be forced on a country from abroad – unless you want full-scale colonization. Of course if the ask the man in the street in Athens today they will say that this is exactly what is happening and I wouldn’t necessarily disagree.”

    What I find is that those who are on the Right who support the EU do so because they believe that the EU will force countries against their will to accept ‘neoliberal’ policies whereas Leftists who support the EU do so because they believe the EU will force countries to against their will to accept ‘socialist’ policies.

    I put these words-‘neoliberal’, ‘socialist’-in scare quotes as these are the terms that in both cases the other side dismisses them as.

    I think that any thinking person whether on the Right or Left should be able to agree that it’s up to the people of each country what kind of monetary or fiscal policies-whether we who do not live there agree or not.

  17. nico

     /  July 20, 2015

    Fact: Poland and Romania wouldn’t have grown as much if it werent for the European union, sponsored heavily by, you guessed it, euro countries.

    Also to call Turkey a European country is incredibly debatable.

    • kri

       /  July 22, 2015

      It’s in the Council of Europe and subject to the EHCR Poland and romania grew because of foreign remittances.

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