A multi-euro Europe: a SFC approach

J. Mazier and S. Valdecantos

The euro zone crisis illustrates the insufficiency of adjustment mechanisms in a monetary union characterized by a large heterogeneity. The paper presents a first version of a four country SFC model aimed at testing alternative versions of a multi-euro Europe, i.e. a euro zone with two euros, a southern euro and a northern euro, combined, or not, with a global euro floating against the dollar. After a brief presentation of the macroeconomic imbalances in the euro zone, the structure of the model is presented, based on previous works by Godley and Lavoie (2007), Duwicquet et al. (2010, 2012) and Mazier and Tiou (2010). In a first version, Spanish and German euros are in a fixed but adjustable exchange rate arrangement against the global euro. They are used only for domestic purposes while all international transactions are undertaken in international currencies (euro or dollar). The euro floats against the dollar and the rest of the world fixes its currency against the dollar.

Simulations are run to show how this new European monetary regime would have faced internal imbalances illustrated by a loss of competitiveness in Spain. When the adjustment criterion of intra-European exchange rates is strict, instable dynamics appears with cumulative devaluations of the two national euros. On the contrary, when the adjustment criterion is more flexible and allows small intra-European balance of payments imbalances, stable dynamics is observed overtime with a depreciation of the Spanish euro against the euro which reduces current imbalances and increases Spanish GDP measured in domestic currency. Devaluation has a positive effect on domestic activity and employment, but at the expense of the production measured in international currency (dollar). Another possible adjustment criterion based on a threshold of foreign reserves held by national central banks gives rather similar results. An adjustment has to be made, although after a longer period of time.

In a second version the German euro leaves the euro zone and floats while the Spanish euro is pegged to the German currency. There is no more room for the global euro.  A process of continuous devaluations of the Spanish euro against the German currency leads to a progressive reduction of the current imbalances but these results are more difficult to obtain and need to impose constraints on the size of the monetary adjustments. Results are more stable when the Spanish euro, instead of being pegged, floats also freely. Spanish depreciation helps to reduce current imbalances and stimulates growth, which is a traditional result obtained with this type of model.

On the whole, preliminary results have been obtained regarding the new forms of European monetary regime which could help to solve the current crisis. However the model has to be improved, especially by introducing variable interest rates and flexible prices.