Giancarlo Corsetti, Pierre Werner Chair at the Robert Schuman Centre and Professor of Economics at the European University Institute, began the lecture by commemorating Robert A. Mundell, who was a leading economics scholar both in and outside of SAIS. Corsetti then shared a quote by Mario Draghi, former President of the European Central Bank and former Prime Minister of Italy. "A common misconception about the European Union - and the euro area - is that they are economic unions without an underlying political union. This reflects a deep misunderstanding of what economic union means…Yet it is clear that, for all its resilience, our union is still incomplete." Mundell, who is fondly remembered as the "father of the euro," provided the theoretical basis for the usage of a common currency. In December 2023, Draghi would go on to say that, "The euro is stable and here to stay."

Mundell greatly contributed to the field of economics, including with the Mundell-Fleming model, the open-economy trilemma, the Mundell-Tobin effect, supply-side economics, the policy mix, and the optimum currency area (OCA) theory. Corsetti's lecture discussed the relevance of Mundell's contributions for the "euro@25" (the 25th anniversary of the adoption of the euro by 11 European Union countries) focusing on the OCA theory. By formulating OCA, Mundell aimed to identify conditions under which countries can be at least as well off adopting a common currency and thus delegating monetary policy, rather than using their own. Countries may have different reasons for adopting a common currency. In Europe, it was a prerequisite for the single market. It may also be a catalyst for political integration, making it inevitable to have to share sovereignty on fiscal and financial issues.

Corsetti reproposed Mundell's key question: whatever the reason for adopting a common currency, under what conditions can this be done at a low macroeconomic cost? When monetary policy is delegated to a common central bank, countries must give up both policy instruments (for example, country-specific interest rates) and (relatedly) adjustment margins (such as the exchange rate and long-run preferred inflation rate) that can help stabilizing country-specific disturbances. Corsetti claims that the distinction between instruments and margins is key to revisit Mundell's contribution. Corsetti re-proposed the original Mundell argument: Suppose an asymmetric shock hits a country - a drop in demand reducing national employment, for example. When countries have their own currency, a monetary expansion can stabilize the shock both by lowering policy rates and thus raising interest-sensitive domestic demand and via currency depreciation (though depreciation may not immediately contribute to raising demand for country exports). When countries have a shared currency, using country-specific monetary policy is not possible. Domestic stabilization requires a combination of fiscal expansion, and cross-border transfers (risk insurance)--- fiscal/market compensation mechanisms can offset at least in part the effects of the original shock on demand/ Also, national monetary policy is less crucial if shocks tend to be "symmetric" across borders (so that the ECB can take care of them), if there are if there is labor/capital mobility, and if there is wage/price flexibility.

Corsetti argued that it is time for a reformulation of OCA theory with a 'Mundellian approach." The first step requires a general analysis of which instruments and margins of adjustment are lost by giving up monetary autonomy and which national asymmetries matter. He proposed a scheme including issues in the stability of the government bond markets---the monetary backstop---; issues in long-run inflation rates (which cannot but be common in a currency area).

Corsetti compared the experience of the US and the EA since 2000---suggesting a striking difference emerging with the GFC. In the US the FED could at the same time stabilize the government debt market and guarantee de facto the face value of US treasuries. The ECB needed to devise a strategy for eliminating the threat of self-fulfilling crises in the debt markets for each of the member states, without however committing to guarantee their face value---which is prohibited in the Treaty. This was possible after a period of intense political negotiations around the crisis, which also coincided with important institutional developments, including the creation of the European Stability Mechanism and the launch of the Banking Union.

With the benefit of insight, a key addition to the OCA theory concerns the political and economic preconditions for states creating a currency union without political union to agree on a minimum institutional architecture that can shield their economy from the disruptive effects of belief-driven debt crisis. The experience of the euro provides key insight on this new page in a OCA 2.0.

Yet, the theory---and the euro area---are now confronting a new challenge. While the EC and ECB policies, together with the ESM, appear to contain destabilizing market dynamics, the area appears to be fragmented along national lines. Sizeable spreads drive the borrowing costs of households and firms apart, questioning de facto the smooth working of a single market. Can a currency union deliver on its promise of stability and inclusive growth settling on an equilibrium where a risk divide prevents a deep economic and financial integration of the euro area?

Corsetti concluded by stating that OCA theory has long shaped the debate on European currency unification. A fresh approach to the questions raised by Mundell, in light of the recent experience and challenges, can arguably go a long way to help reframing the debate today in a constructive manner.

hosted by Professor Renaud Dehousse


Robert A. Mundell (1932-2021) was a member of the Johns Hopkins SAIS international economics faculty and taught at SAIS Europe for four years, during the period 1959-2001. Much of his pioneering work in monetary dynamics and optimum currency areas, which resulted in his Nobel Memorial Prize in Economic Science in 1999, was conducted during his time in Bologna.

The Lecture is part of the broader Johns Hopkins SAIS Global Risk Conference which has been made possible with the generous support of Mr. James K. Anderson, SAIS Europe Alumnus and Advisory Council member, and Johns Hopkins University Trustee.

GIANCARLO CORSETTI

Giancarlo Corsetti is Pierre Werner Chair at the Robert Schuman Centre and Professor of Economics at the European University Institute. Previously he was Professor of Macroeconomics at the University of Cambridge, where he was director of the Keynes Fund and of the Cambridge-INET Institute. A Fellow of the British Academy, he is a consultant at the European Central Bank and a regular visiting professor in central banks and international institutions. Corsetti is also a Research Fellow of the Centre for Economic Policy Research (CEPR), where he serves as coordinator of the European Macroeconomic Policy Research and Policy Network (RPN). He is a member of the European Economic Association, where he served as Program Chairman of the 2007 Annual Congress in Budapest. Since 2018, Corsetti has been a member of the United Nations High-level Advisory Board on Economic and Social Affairs. His contributions range from models of the international economy and open macro models; to empirical and theoretical work on currency, financial and sovereign crises; monetary and fiscal policy; and international finance.