Unlike the Czech Cabinet, University of Leipzig Professor Günther Schnabl says the Czech Republic made a mistake by not adopting the euro before the crisis started. The crisis experience so far confirms that having a single currency pays off, he says. Moreover, euro adoption is a logical step in the development of all EU countries, Schnabl says.
“There is very strong economic integration among EU countries. When they got rid of customs barriers, it turned out that exchange rates, including those on the single European market, would show huge swings as a result. Eliminating exchange rate swings and stabilising the currency meant introducing a single currency, the euro,” he said in an interview with Aktuálně.cz.
Two arguments against the euro
But not all member states have the euro. Why should the Czech Republic introduce it?
The Czech Republic is a small country, its economy is small and it trades intensely with the eurozone and other central and eastern European countries. Capital markets are getting integrated, which reduces transaction costs.
Isn’t it advantageous to have our own currency when European countries are sinking deeper and deeper into the crisis?
There are two principal arguments against stable exchange rates and the euro. First – a bigger risk of crises. That stems from the eastern Asian crisis ten years ago. Eastern Asian countries at that time stabilised their exchange rates, which caused an inflow of capital and gave rise to market bubbles. That’s why we should now maintain currency flexibility, and that leads to flexible transaction costs for international capital markets. That can restrict the inflow of western capital at a suitable moment.
It’s a question of whether such an interpretation corresponds to reality at present. I think we have concluded in the meantime that it does not. If a national economy, trying to catch up with advanced countries, allows these flexible exchange rates, then currencies appreciate and capital markets rely on the appreciation because they know it will bring them profit. Then speculative capital inflow starts, and that goes hand in hand with bubbles, with a crisis, and maybe even some worse things.
So changes in exchange rate against the main world currencies do not necessarily help economies in their fight with the financial crisis?
No, that’s what the Korean example shows. The country was hit by the Asian crisis despite allowing flexible exchange rates and despite the fact that its currency strengthened. That’s why I think this is no solution. The second argument against a single currency says that adopting a single currency causes a loss of geopolitical autonomy. That suggests a question whether losing it is good or wrong.
The truth is that money in a number of emerging markets is so unstable for political reasons that handing the powers over is useful. The European Central Bank has really a very trustworthy objective – low inflation. It can also ease the asymmetric shock (editor’s note: economic problems that hit only one country in a given region). In the instant that the development of economies is accompanied by asymmetric shocks, they lose the opportunity for any independent reaction.
Currency losses and inflation
Is your statement about the advantages of the euro also true at a time when demand for Czech exports is falling and the weaker crown could help counter that?
Of course it’s possible that it’s better to have the possibility of a financial policy reaction in the first stages of a crisis. But I have noticed that in an economy, which gets used to reacting flexibly every day, the financial policy becomes the victim of political objectives in the end. That can result in an unstable financial policy, which leads to an increased instability in the entire economy, higher interest rates etc.
The Slovaks have introduced the euro, while the Czechs have been delaying the adoption of the single currency. Right at this moment, isn’t the postponement a better solution for us?
Do you mean in connection with the current crisis?
Yes.
The way you do it has its pros and coins. The Czech Republic now, of course, can depreciate its currency in reaction to the crisis. That means higher exports. On the one hand, the country can “export” itself out of the economic crisis, but that would result in higher inflation.
When I put money on the market and it depreciates, I get a short-term positive effect, but a negative long-term effect. Slovakia can no longer depreciate its currency and the only way for it to stand the competition rests in increasing productivity, cutting wages, prices etc. That is painful in the short run, but from the long-term point of view I have to say this is a very good way how to get out of an economic crisis. My national economy would then do better than an economy that “exports” itself out through inflation.
Inflation and currency weakening maintain structural problems. Slovakia will have no other option that to deal with these problems in the corporate sector right now. The others, who depreciate their currencies, won’t do that of course. And I don’t think that businesses that adopt to the depreciation would be much better off in the end.
Does it also apply to such a critical situation where the industry, including exports, has a 25% shortfall?
This is really the biggest problem that all of Europe is dealing with now. It does not concern just the east, but especially southern Europe, Greece, Spain, Italy. In the past, as soon as they stopped being competitive, they started depreciating their currencies and achieved their market positions again. This is not possible any longer. In order to succeed today, they would have to undergo restructuring, cut wages.
Just to compare – Germany has always reduced its wage costs, while Italy increased them, and then suddenly it turned out that there is a huge difference in the performance of these two economies. Italy now can choose between two different solutions to the problem – either reducing wages or “collectivising debts”, which means the Germans will pay for Italy’s debts. But this is a method that should raise concerns, since it gives rise to a moral hazard. Certain clubs of countries then wait for money flows from other countries.
We in Germany know that well. In the south, we have regions like Bavaria, Baden-Württemberg, Hesse whose economies perform very well. Then we have Berlin that has always been used to getting money from the south. People in Berlin do nothing but wait for money to come in from other regions. That, of course, hampers the development of the national economy in such areas.
The current crisis shock can bring change to the practice of separated markets. It is possible that the European centre will have to settle Greek debts and that suddenly everyone will be promoting transfers, which was absolutely unthinkable in the past. Now it seems that the financial policy, until now at a national level, is starting to move in a different direction thanks to the crisis. And already now, a moral hazard is emerging as financial resources flow constantly from Brussels to Athens.
Don’t you fear that from the viewpoint of the rich EU members, the Czechs and the Hungarians will become the new Greeks? And when they introduce the single currency, that you will have to rescue even their public finance?
We, of course, don’t know what will happen. These are countries that are going through a very dynamic development. They might be different in some respect, but all of them now record a growth in all of their activities, they show a fast growth, high capital accumulation. But it may change, nobody knows. If we knew that financial injections are going to come, then maybe people in the new countries would change their behaviour.
ČNB rates don’t matter
The Czech National Bank decreased interest rates at the start of the recession to help exporters. Now the bankers are threatening to increase the rates to prevent the crown from losing further. Do you think this is a good strategy?
I think it does not matter at all what they do. If they prevent the currency from depreciating, interest rates will be soaring. And if interests are soaring, then it will not be possible to repay long-term investments that were financed in a short-term way. The banking sector will then collapse. If the currency weakens, with debts in euros instead of Czech crowns, the banking sector will collapse as well. From this point of view, I can see no major difference.
The Czech Republic does not have such great debts, so the problems there perhaps won’t be as big as in the Baltica states. Some eastern European countries have run into debts to a much greater extent, and it will be painful for them. It is the same cause of problems like in the USA. I now expect similar problems to come from eastern and southern Europe too.
Does it matter from the viewpoint of the European Central Bank whether the euro sells at 24 or 30 crowns?
The eurozone is large, the Czech Republic is small, and that’s why it does not matter. But there is one big difference between Slovakia and the Czech Republic at a time of crisis. Interest rates are now rising in the Czech Republic, that will not happen in Slovakia because Slovakia is part of the eurozone and interest rates always remain stable in large monetary areas.
Why the Visegrad fear the euro
Poland wants to enter the system ERM-2, which would prepare the country for euro adoption, at any cost. But most Czech economists say such a move is risky because we would give up the possibility to change the exchange rate. Who do you think is right?
If you do enter, then it will depend on the strategy that you can choose. If it is the Estonian way or the Slovak way (editor’s note: Estonia opted for a fixed exchange rate to the euro, while Slovakia admitted that the exchange rate may change during the period in the ERM-2).
By having a fixed exchange rate, Estonia of course loses the macroeconomic flexibility and have to adopt all economic shocks to the fiscal policy. And this I think is the reason why there was such a fear of euro adoption in Poland, the Czech Republic and Hungary in the past years.
