1996 UBS Redux: Who Should Have Been In The Euro?

No, it's not Friday and no, it's not a total joke, but UBS' Stephane Deo takes a retrospective look at what his firm's economists were saying back in 1996 about who should be in and who should not be a part of the Euro 'project'. Given the growth and performance of the 'ins', it seems perhaps we should, as Deo says, always pay attention to economists for a happy and prosperous existence but it is somewhat insightful that as far back as the beginning of this experiment, it was relatively clear (in 1996) that proximity to Maastricht rules, political flexibility, and real economic prospects separated the 17 nations, leaving an at-the-time optimal five (or maybe six) nations. There are many yeah-but comments with this look-back, but for sure, it provides a quick-and-dirty view on what these countries looked like before whatever integration they have now, and maybe what they should revert to once again - it is certainly cathartic to see the peripherals already standing so far from the core.


UBS - Stephane Deo - What if – economists had been listened to?

This is, perhaps, the easiest question to answer. The secret to a happy and prosperous existence is to listen to economists all the time.


Back in 1996 UBS published research saying that the Euro should consist of five or six countries (Germany, Austria, the Netherlands, France, Luxembourg and, with a certain degree of charity as to the debt burden, Belgium – summarised in the Venn diagram above). What would have happened if the Euro had consisted of those countries, and no more?

The chart shows the difference in growth between the strongest and weakest Euro member (given the Euro’s current composition), alongside the difference in growth for the strongest and weakest Euro member in a perfect world (where economists decide everything). The growth differential for the Euro 17 is huge, unmanageable, and symptomatic of an entirely dysfunctional monetary union.

The growth difference for the Euro 6 (actually 5, as Luxembourg has been excluded from this analysis) is steady, modest, and entirely manageable with a single interest rate and a single exchange rate.

In other words, a Euro consisting of the six countries would have worked in economic terms. Monetary policy would have been appropriate for all parts of the union. That would not have prevented fiscal strains as the global financial crisis developed, but the fiscal strains might have been somewhat lessened (because fiscal policy would not attempt to compensate for an inappropriate monetary policy).

How the eleven excluded from the Euro would have fared is a more difficult question. Would Greece have had so profligate a fiscal policy if it had been able to run a more appropriate monetary policy? Would the property bubbles, and ensuing crashes, in Spain and Ireland have taken place if monetary policy had been sensitive to their needs? While there are disadvantages in using a less liquid currency, it seems likely that the advantages of a more appropriate domestic monetary policy would have offset the potential disadvantages of a more volatile exchange rate. After all, in all of these economies, the domestic economy far outweighs the external in terms of its importance.

Unsurprisingly, therefore, it seems that the world and in particular the Euro would have been a better place had economists’ advice been heeded.


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