Before the Eurozone was formed, many economists warned that it would cause problems because it is impossible to have one monetary policy that is right for all the economies of a diverse set of countries. And having one currency means having one monetary policy. But the symbolism of a common currency for the project of binding Europe together politically seemed too valuable to give up. So the varied countries in the Eurozone (the blue countries in the map below), have had a one-size-fits-all monetary policy—eleven of them since January 1, 1999, and others since they joined the Eurozone later on. (The last to join was Estonia, in January 1, 2011.)
Now, in 2012, countries such as Portugal, Spain, Italy and Greece could use more expansionary monetary policy than what is right for Germany and some other countries in the North of the Eurozone. Getting back an independent monetary policy requires getting back one’s own currency and so requires exiting the Eurozone. But it is hard to exit the Eurozone in an orderly way—and exiting in a disorderly way risks causing another financial crisis. The aim of this post is to propose an orderly way to restore some degree of monetary policy independence to the different parts of the Eurozone. It might roil financial markets too, so I am not necessarily advocating it, but I see it is preferable to any country simply exiting the Eurozone.
So my objective here is to design a minimum-distance modification to the Eurozone that adds some ability to adjust monetary policy independently for different parts of the Eurozone. The basic idea is “one central bank, two currencies.” In this plan, the Eurozone remains together and the European Central Bank (ECB) continues to determine monetary policy for the entire Eurozone. But the ECB now decides monetary policy for both a “North Euro” and a “South Euro.” The North Euro and the South Euro start out with an exchange rate of 1 to 1, but ultimately are allowed to drift apart in value.
One could easily go further by having one central bank for the North Euro and another central bank for the South Euro, but the policy of “one central bank, two currencies” would help assure the markets that the monetary policy of the South Euro wouldn’t go wild. In the ECB, there could be an informal understanding that the views of those from the relevant countries had a greater weight in setting the monetary policy for those countries, but the official voting rules would be as now: votes from the entire Governing Council of the ECB would apply to both the monetary policy for the North Euro and the monetary policy for the South Euro. In this context, we are in the realm of the second, third or fourth best. One can’t expect a perfect setup given the original economic sin (which might have been an original political virtue) of setting up the Eurozone as it is in the first place.
The official names of “North Euro” and “South Euro” are helpful to make clear that legally they are both “Euros” (which, of course, doesn’t really solve the legal mess that dividing currencies creates). But I am imagining that the press and the public would soon use a different naming convention: that the “North Euro” would end up being called just the “Euro” by almost everyone, while the “South Euro” would end up being called the “Mediterano.”