Kenen on the euro

Barry Eichengreen, Charles Wyplosz, 21 December 2012

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Peter Kenen, who passed away peacefully in Princeton, NJ earlier this week, was one of the leading international monetary economists of his – and any – generation. Peter made fundamental contributions to many topics but none more consistently than the question of the euro. That he importantly influenced both the theory and practice of European monetary integration is all the more remarkable for the fact that he was an outsider, an American rather than a European, and that he was sceptical about substantial aspects of the project. But Peter was also supportive of Europe and uniquely able to strike a tone that caused his sceptical insights to be taken seriously and even sympathetically.

Early work on optimum currency areas by Robert Mundell had emphasised the symmetry or asymmetry of disturbances hitting different regional economies as a key criterion on which to gauge their suitability for sharing a common currency. Peter took this insight further by arguing that disturbances were often sector specific and that the diversification of regional economies was therefore a key consideration in gauging their suitability for monetary union (the better diversified an economy was, the less likely it was to be badly destabilised by a sector-specific shock). (Kenen 1969).

We now know that Kenen flagged a problem for which the Eurozone could have been better prepared. With an outsized capital-goods producing sector, Germany benefitted from a strong positive shock as a result of China’s emergence onto the global stage, given the Chinese economy’s voracious appetite for capital goods. Portugal and Italy, on the other hand, specialised much more heavily in consumer-goods producing sectors and felt the brunt of Chinese competition. No Eurozone member was sufficiently well diversified to shrug off this kind of shock, something that should have made the euro’s architects think twice.

Specifically, they should have thought again, Kenen argued, about the coordination of national fiscal policies, the need for a common Eurozone budget, and mechanisms for transferring fiscal resources from booming to depressed regions. While these insights were not entirely unique to Peter, his formulation was definitive and particularly influential (see, for example, Hartland 1949; Ingram 1962). Whether monetary union without at least limited fiscal union is viable is now the crux of the debate over the future of the euro. Had they paid more attention to Kenen’s insights, European leaders wouldn’t have been so late to the game. They would have paid closer attention to the fiscal implications of their collective institutions.

Not just economics …

More than any other economist, Peter understood that monetary union was a legal as well as an economic construct. His careful parsing of the Maastricht Treaty explained to the economics profession exactly what the treaty did and did not allow (Kenen 1992). Currently there is much confusion about the legal basis of a single supervisory mechanism and ultimately a European banking union complete with common deposit insurance and a common resolution mechanism. Were more scholars to take Kenen’s approach, confusion would be less, progress more.

Peter even anticipated the debate over TARGET2 imbalances, observing in 1999 that it was possible to “easily conceive of conditions…in which one [national central bank] would be reluctant to build up claims indefinitely on some other national central bank.” (Kenen 1999). The point is obvious now. To Peter it was obvious then.

Finally, Peter observed that the possibility of a member state exiting from the Eurozone could not be ruled out but warned that European officials should be cautious in bandying about the idea (Kenen 1999). “The costs of defecting,” he wrote back in 1999, “could be very high.” The defector would run the risk of financial collapse, and its former monetary union partners would be likely to experience serious adverse financial consequences as well. European leaders have now come around to this position – that a Greek exit would be costly and should be avoided if at all possible – but only after having sent mixed signals for a considerable period of time.

Peter Kenen was many things: theorist, teacher, mentor, institution builder and policy advisor, but not least leading thinker on European monetary integration.1 European leaders would honour his memory and also do themselves loads of good if, when pondering the future of their monetary union, they took his insights to heart.

References

Hartland, P (1949). “Interregional Payments Compared with International Payments,” Quarterly Journal of Economics 63 (3) 1949, pp.392-407;

Ingram, J (1962). Regional Payments Mechanisms: The Case of Puerto Rico, Chapel Hill: University of North Carolina Press (1962).

Kenen, P (1969), “The Theory of Optimum Currency Areas: An Eclectic View,” in Robert Mundell and Alexander Swoboda (eds), Monetary Problems of the International Economy, Chicago: University of Chicago Press (1969), pp.41-60.

Kenen, P (1992). EMU after Maastricht, New York: Group of Thirty.

Kenen, P (1999). “Outlook for EMU”, Eastern Economic Review 25(1), Winter 1999, p.113.


1. We will have more to say about personal aspects of Peter elsewhere.

Topics: International finance
Tags: optimal currency area, Peter Kenen

Professor of Economics and Political Science at the University of California, Berkeley; and formerly Senior Policy Advisor at the International Monetary Fund. CEPR Research Fellow
Professor of International Economics, Graduate Institute, Geneva; Director, International Centre for Money and Banking Studies; CEPR Research Fellow