Eurozone Creation and Possible Exits: Political, Institutional, Monetary and Economic Issues - An Analysis of the Key Stress Points of the Single Currency and Their Interactions

Abstract

This paper argues that EMU has been and continues to be a politically driven process. In this perspective, it examines the issues and the implications of potential Euroexit and Euro break up: it underlines that these processes would have a prominent political dimension, as was the case for the creation of the euro. A complex-system network approach is adopted to examine the principal vulnerabilities of the single currency without a state. The euro is at the center of an economic and monetary union with unique political, institutional and policy features. The Eurosystem – which comprises the European Central Bank and National Central Banks - is a construction with no parallel in time and space. The heart of the interactive dynamic web in the Eurosystem is a complicated payments and settlements system: Target Balances. Beyond their accounting functions, the Balances have macroeconomic, macroprudential, balance of payments, banking and monetary – geographical and area-wide – implications. These characteristics were not explored and understood until a few years ago. The risk features continue to be downplayed. This paper tries to bring the analytical and policy understanding one step forward. It shows that - beyond the relevant and complicated assessment of changing underlying factors, also on a country basis - a long-term relationship exists between monetary base creation in the Euro area and the Target System. It argues that the workings of the System in its present form blunt the inherent adjustment mechanism of a currency union. Five key areas of stress of the euro are identified and potential systemic fault lines are examined, with novel insights on transmission mechanisms of contagions and risk spillovers. The findings help outline remedial comprehensive actions of political economy to improve the resilience of the Eurozone.