Robert Mundell, the stepfather of the euro

The spiritual father of the euro, that’s how Robert Mundell is described. The Canadian economist died last Sunday, which was reason in many obituaries to reflect on his fatherhood of the European currency. In 1999 Mundell was awarded the Nobel Prize in Economics, and that was no coincidence: in that year the single European currency was launched. And indeed, Mundell’s theory played an important role in this. But there is an important caveat.

Imagine you are designing a revolutionary new ocean liner. But at the yard it is built with inferior nails, and on the maiden voyage the captain sails way too fast in the fog – and that during iceberg season. After that, would you like to be known as the spiritual father of the Titanic?

Mundell’s design, again from 1969, was based on a ‘optimal currency area‘. This is an area where not only capital but also labor travels freely and neutralizes shortages or surpluses in the labor market in parts of the area. There should also be a common budget, or at least a mechanism of redistribution, whereby sub-areas where things are going well temporarily, automatically hand over to areas where things are going down temporarily.

In order for a currency to function properly, “automatic stabilizers” are needed. Because exchange rates between individual currencies, which could neutralize relative prosperity and adversity, are no longer there.

Mundell’s ideal essentially described the United States, where such an automatic mechanism exists in the distribution of the federal budget among the states. Traditionally, labor mobility has been great.

But where Europe created its euro in about seven years, the US took a long time to discuss the dollar. Treasury Secretary Alexander Hamilton succeeded in 1791 (15 years after independence) to convince the states to throw all debts together and see them as common. Until well into the nineteenth century, different kinds of dollars circulated in the US. And it wasn’t until 1913 that the now-famous Federal Reserve, the central bank as we know it today, was established.

In Europe, the euro was introduced in the hope and expectation that it would later develop into such an optimal currency area. Because it wasn’t at all at the start. And essentially it still isn’t. The euro was, and is, fundamentally a political project to which the economy must slowly adapt.

That is not to say that it cannot be a sustainable success. We are working very cautiously on a larger common budget – see, for example, the recent European aid package of EUR 750 billion. A banking union is reasonably well underway, although it is not completely finished yet. A common capital market is emerging. And who knows, it may well come from a commonly felt fiscal discipline among the countries of the euro. Labor mobility within Europe appears to be increasing (before the pandemic that is), while that in the US is declining somewhat. And there are convinced Europeans who wish the continent its own ‘Hamilton moment’, where all debts merge and become a common responsibility. Although enthusiasm for this increases with the size of the national debt.

So let’s not make it more beautiful than it is: Mundell’s legacy is far from finished. We are perfecting the Titanic while it has already sailed. In the hope that Leonardo DiCaprio will get home safely this time.

Maarten Schinkel writes about economics and financial markets.

Robert Mundell, the stepfather of the euro
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