Scott Sumner  

Could a successful Brexit wreck the eurozone?

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Timothy Lee has an excellent new post:


Brexit isn't the most serious threat to the EU -- the euro is

One surprising thing about Britain's vote to leave the EU is that the British economy has been doing better than a lot of European countries. Unemployment in the United Kingdom has fallen to 5 percent, its lowest level in a decade. In contrast, the average unemployment rate among countries that (unlike Britain) have joined the EU's common currency, the euro, is still above 10 percent.

And many economists argue that's not a coincidence -- that poor policies by the European Central Bank have systematically weakened growth in countries that have adopted the euro.

A new paper from economist David Beckworth makes the case that the economic woes of eurozone countries like Spain and Greece can ultimately be traced back to the euro itself. He argues that other problems in those countries, like their problems with high debt, were made worse by the ECB's tight-money policies.

This argument has huge implications. It suggests that without reforms, eurozone countries could continue suffering from slow growth and abnormally severe recessions for decades to come. That, in turn, will fuel public resentment against the EU and increase the danger that other countries will follow the UK's lead.


The stock markets that have been hardest hit by Brexit are in places like Italy, Spain and Greece, the epicenter of the on and off again eurozone crisis. This suggests that investors fear a contagion effect. Indeed with the sharp rally today, the FTSE100 is actually above it's pre-Brexit level, and even the more meaningful FTSE250 (which focuses on British domestic stocks), is only down about 7%, not much different from France and Germany).

I'm pretty skeptical of anyone's predictions as to how all of this will play out, including my own. Just to give you a sense of how hard this is to predict, consider the following hypothesis. Suppose Britain is able to successfully negotiate a Norway/Switzerland style agreement with the EU, and is also able to avoid the recession that almost everyone is now predicting. What then?

One effect would be to discredit the "experts" (like me) who warned that the UK should not exit the EU. And what implications might long-suffering citizens from Greece and Portugal draw from Britain's successful Brexit?

And here's something else to think about. If Greece noticed that the UK did well with its Brexit, and that led to a "Grexit", the results might be far worse. The Greek banking system might collapse for reasons explained in Timothy Lee's post, and the contagion effect could also hit the banking systems of the other PIGS.

In other words, while real factors are the dominant influence on long run growth, over business cycle frequencies it is monetary factors that dominate. The one issue Britain does not have to deal with is exiting the euro. And that's the most difficult problem of all.

Just to be clear, it's by no means certain that Britain will be able to negotiate a Norway/Switzerland type solution. The two sides are still far apart on immigration, and the EU is in no mood to hand out favors to the Brits. But in the end, serious countries do tend to muddle through, and come up with some sort of agreement. If that tempts some of the eurozone members to also try exiting, we may get a clear test of my view that monetary shocks tend to be more disruptive than real shocks, at least in the short run.

PS. I hope EU negotiators don't read this post and vow to make the UK suffer. If so, I apologize to Boris.

PPS. The mainstream media still hasn't quite figured out that Brexit is a problem because it tightens monetary conditions. But they are getting closer, worrying that Brexit leads to "tighter financial conditions."




COMMENTS (18 to date)
ThaomasH writes:

But "forcing" UK to accept freedom of movement as a condition of access to the single market would be to UK's advantage.

As for the Euro being the source of EU's problems, well Paul Krugman told us that before the Euro existed. Which is not to say that ECB's tight money policy did not make things worse.

foosion writes:

Are there many economists who don't think the euro was a terrible idea, because of its effect on monetary policy or due to fiscal policy or both?

EU officials are very clear that access to the single market requires accepting EU immigration policy (see Norway/Switzerland). UK wants market access without immigration. A clean solution is not obvious.

Apparently, the UK doesn't have the bureaucracy necessary to negotiate the trade deals it wants, leaving the EU means it loses a lot of bargaining leverage with other countries, trade agreements tend to take a lot longer than the two year exit period under EU Article 50. About a third of the UK economy is exports.

Matthew Moore writes:

'PS. I hope EU negotiators don't read this post and vow to make the UK suffer. If so, I apologize to Boris.'

Don't worry, this is actually their primary thought already. They have said as much. Happily the powerful German industrial lobby has said tariffs are in no one's interest.

Very oddly, from my perspective, EU leaders deny that the UK could opt out from free movement by saying it is the 'cost' of participation in the single market. This is bizarre to me, as it reinforces the idea that it is a harmful policy imposed by Brussels on member states. Now maybe they are saying it's a solution to some sort of democratic prisioners' dilemma, but the rhetoric is terrible.

If freedom of movement is so great (which it is, and I have availed of my right to work in two EU countries), then it should be a punishment to agree to exclude the UK from it.

Matthew Moore writes:

PS I actually don't think it is in the EU's gift to prevent post-Brexit UK economic success, provided sensible domestic and trade policies are followed (uncertainty here). WTO tariffs aren't that high.

foosion writes:
WTO tariffs aren't that high.

Tariffs are not a major issue in international trade. The main issue is regulations - content, safety, green regulations, etc., etc. Those can get very involved and burdensome, especially if you are trying to sell to markets with different regs. One big UK complaint was complying with the EU's regs. If they want to sell to the EU, they are going to have to make sure exports comply. If they want to sell to other areas, they'll have to negotiate complex regs with those countries, without the leverage the EU has.

Matthew Moore writes:

@fooion, EU exporters already comply with those regulations. Where's the additional cost?

Matthew Moore writes:

@fooion, Lichtenstein is in the EFTA without absolute free movement. Article 112 is designed for that exact purpose.

jon writes:

Matthew Moore writes:

If freedom of movement is so great (which it is, and I have availed of my right to work in two EU countries), then it should be a punishment to agree to exclude the UK from it.
If that was the proposed punishment, this renegotiation would go pretty smoothly.

Scott Sumner writes:

Everyone, Lots of good points, I don't have much to add.

I believe that most European economists thought the euro was a good idea, but am not certain.

Lorenzo from Oz writes:

Scott: you may not be aware of this little gem: there were a lot of European economists who were keen on the Euro and openly dismissive of concerns by American economists.

foosion writes:

@Matthew Moore, one of Leave's complaints was having to comply with extensive and burdensome EU regulations. If they want to export, they'll have to continue to comply with them for anything they want to export. To the extent retooling is expensive, they might continue to comply for all existing products.

foosion writes:

Consider ttps://medium.com/@WhiteWednesday/what-s-wrong-with-the-wto-option-1fcbf5e8cee6#.o7oop3ug0 regarding the WTO option. It points out that not only do you have to comply with regulations, but also, for example, you have to go through customs and prove compliance with regs, which can mean delay and cost.

Matthew Moore writes:

@Scott

One of the reasons that the Leave campaign was able to discredit the economic warnings of the Remainers, was that the very same people were strongly in favour of joining the Euro.

This was one of their more effective ad spots: https://youtu.be/TTv7UoK8oJY

It wasn't the consensus view of the establishment in quite the same way as Remain was however.

Gordon Brown should get credit for at least two very important things: 1. Bank of England independence and 2. Devising a set of convergence tests so strigent that they practically ruled out joining the Euro.

R Richard Schweitzer writes:

Is it possible that we are likely to see the development of domestic currency systems within members of the euro zone in addition to the use of the euro for inter-zone settlements?

ThaomasH writes:

All trade negotiations are upside down: I agree not to harm myself with restrictions if you'll not harm yourself. For the EU not to harm itself by restricting UK access to the single market in return for UK not harming itself by restricting movement is just the way negotiations work.

After reaching that "deal" Parliament would be crazy not to reject it and just "Remain."

Charles R. Williams writes:

The euro is the problem? Let's apply this analysis to the situation of Puerto Rico - a bankrupt entity like Greece, over-regulated by itself and by the larger political entity with a bloated public sector and huge pension liabilities. Does anyone seriously contend the Puerto Rico's problems would be solved by the Fed buying more treasury bonds or cutting short term interest rates? The dollar is not the problem in Puerto Rico.

The real issue in Europe is not the common currency but an integrated banking system built on the assumption that default is unthinkable for sovereign debt combined with a pattern of consumption and production fueled by unsustainable growth in sovereign debt that cannot be honored by the countries that issue it.

Mr. Econotarian writes:

Blaming the Euro for the problems of Greece, Italy, and Spain is silly.

The problems of those countries are regulatory, especially with regards to labor regulation.

If they weren't in the Euro, sure they'd inflate their currency, and it might be a back-door to reduce effective minimum wages, but if they simply reduced effective minimum wages in the first place you wouldn't have to steal value from savers.

If they left the Euro, could the government spend more (inflated) money? Maybe, but you'd have to inflation-adjust the multiplier. And given the nature of those countries, we know the spending would go to remove people from the labor pool (early retirement) or to their cronies for silly "infrastructure" spending that is unlikely to create much infrastructure.

Venezuela isn't on the Euro, and it is still screwed up...hint: if your government has the word "Socialist" in the ruling party, it doesn't matter if you are on the Euro, you are in trouble.

Scott Sumner writes:

Lorenzo, Yes, I do recall that one.

Charles, You said:

"The dollar is not the problem in Puerto Rico."

I agree.

Mr. Economotarian, You said:

"Blaming the Euro for the problems of Greece, Italy, and Spain is silly.

The problems of those countries are regulatory, especially with regards to labor regulation."

Actually both are to blame, the euro made the recession worse, and the regulatory climate explains the long run growth problems.

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