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Euro area reform: No deal is better than a bad deal

Peter Bofinger, (2018), “Euro area reform: No deal is better than a bad deal”, VoxEU, 15 Μαΐου

Given the focus on ‘risk sharing’, it is surprising that the authors do not explicitly explain what specific risks they want to be shared. Their proposals focus on the risk of idiosyncratic demand shocks and the risk of a national banking crisis. But this neglects the unique and existential risk of euro area membership. Monetary union exposes its member states to an insolvency risk which is absent for similar countries which have a national currency. When a country adopts the euro, its debt is redenominated from the national currency into the euro. Thus, member states are in a similar situation as emerging market economies which can only lend in a foreign currency (‘original sin’). In a crisis they can no longer rely on the support of their national central bank.

This specific risk is aggravated by an easy exit option that the single currency provides for investors. If, for example, a Japanese pension fund is no longer willing to hold Japanese government bonds and decides to hold US treasuries instead, it is confronted with a currency risk. For institutional investors that are required to hold safe assets, this ‘currency wall’ is difficult to surmount. Within the euro area this wall has been removed so that investors can exchange domestic bonds into bonds of other member states without an exchange rate risk.

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