A currency area breaks up spontaneously: The case of the euro zone

A currency area tends to break up spontaneously because of the growing heterogeneity of the member countries, due to two mechanisms: The disappearance of currency risk leads to a different productive specialisation among the countries, leading to a divergence of per capita incomes; When a country has lower potential growth than the currency area average, the currency area’s interest rates are too high for that country, which weakens its investment and depresses its potential growth even further. These two mechanisms that lead to the countries’ growing heterogeneity are clearly present in the euro zone, and may lead to its break-up. To prevent this, the heterogeneity must be corrected, which in the short term can be done via a very expansionary monetary policy, but in the long term can only be done via the introduction of a federal budget of sufficient size .