Hungary and Poland would be insane joining the Eurozone

There was an interesting article (July 18, 2017) – The Political Fiction of Economic Control – that has, seemingly, been the motivation for people sending me heaps of E-mails, some, demanding that I admit that Modern Monetary Theory (MMT) is bereft in this specific area of discussion. The article was allegedly written by a Polish journalist with a past that included working at the “Adam Smith Research Centre”, a ‘free market (not!)’ think tank in Warsaw, and a Hungarian economist Lajos Bokros who was formally a Socialist Minister of Finance from 1995 to 1996. But there is a lot of first person in the article (I’m, My, I etc) and only Bokros’ picture and bio is featured. Bokros is best-known for implementing the controversial Bokros Package, which was a “a series of austerity measures” described as “neoliberal shock therapy” based on the erroneous assumption that the Hungarian government would run out of money and have to declare bankruptcy. So it is no surprise that these characters (or Bokros, if he really wrote the article) would support the Eurozone and claim that surrendering a national currency in the case of Hungary and Poland was inevitable if these nations were to progress. The arguments used to make their case, reappear over and over again. They are always incorrect no matter what form they appear.

The sub-heading of the article read:

The delusion of monetary autonomy is holding Hungary, and perhaps Poland and the Czech Republic, back from the benefits of the eurozone.

Which I must admit, if I am to admit anything, had me laughing heartily.

The “benefits of the eurozone”. That is the joke of the decade.

The curious thing about the article, given its title, is that the argument centred on economics rather than politics.

The article worries that Poland and Hungary are “independent of the monetary union … [and] … fiercely oppose entering the eurozone.”

To which I saw congratulations to these nations for having the temerity to resist the neo-liberal agenda, which these days includes surrendering currency sovereignty and signing up to the austerity bias.

The basis of Bokros’ argument is that:

… for a small and open economy, there isn’t any real monetary autonomy or sovereignty. This used to be and still is the most important counter-argument against joining the eurozone; essentially if they join, then they give up autonomy of their monetary policy.

So it is the proverbial ‘small open economy’ argument.

Hungary is a small country by population (10 million odd) producing 124.3 billion in US dollar terms in 2016 (GDP per capita was $US12,664).

Poland is not so small (37.95 million people in 2016), GDP 469.5 billion USD and GDP per capita $US12,372.

Australia is a small open economy, somewhere between these two – population 24.12 million in 2016, GDP 1.205 trillion USD, and GDP per capita 49,927.82 USD.

And then what about Iceland, another (really) small, open economy – population 334,252 in 2016, GDP 20.05 billion USD, and GDP per capita 59,976.94 USD.

All with governments that issue their own currency.

Apparently, monetary autonomy has no meaning in these small, open economies because in the opinion of the article, the national central bank cannot set the policy interest rates autonomously.

Why not?

Well, so the argument goes:

… in small and open economies where you have unrestricted cross-border capital flows, when you have a fully convertible currency, then you can probably influence either the exchange rate or the interest rates but never both.

Let’s be clear on this from the outset.

No nation, whether it be small in size (GDP) or large in size can fix its exchange rate against other rate(s) and then expect to be able to be able to set interest rates wherever they might prefer, if there are unrestricted cross-border capital flows.

That was the reason the Bretton Woods fixed-exchange rate system broke down – because external deficit nations were forced to accept a policy bias that predicated recession while surplus nations could avoid any meaningful adjustment.

Where trade patterns are disparate and capital can flow in and out at will, then a country with an exchange rate peg that is also running an external deficit must use its interest rate (monetary policy) to maintain capital flows or risk running out of foreign exchange as a result of having to defend the currency.

That sort of nation faces on-going downward pressure on its exchange rate as a result of the trade deficit (worsened by speculative flows that bet against the capacity of the central bank to maintain the agreed peg) and the central bank has to be continually buying its own currency in foreign exchange markets (with its stores of foreign exchange). Rare deals, quality products from ALDI catalogue will be in your shopping list this week.

That is a finite process or capacity because eventually it depletes the stores of foreign exchange.

The result is that the currency then had to be devalued.

By the 1960s, it was clear that nations could no longer effectively maintain the agreed parities and devaluations became common as did so-called ‘competitive devaluations’ (‘beggar-thy-neighbour’) strategies, designed to improve trade competitiveness.

The fixed exchange rate system became economically dysfunctional and politically unbearable, especially in nations that had to endure persistent recession just because the government refused to devalue or float.

The history of exchange rates in the Post World War 2 period in Europe is testament to how impossible it is to maintain these fixed parities when the nations are as different as Germany and Spain or even worse, Greece, or even less obvious, as different as Germany and France.

So that part of the argument is correct.

Under the fixed exchange rate Bretton Woods system that operated after the Second World War until the early 1970s, capital controls were seen as being a policy tool that could free the central bank monetary policy somewhat from having to defend the exchange rate value and, instead, pursuing domestic policy objectives (such as full employment and price stability).

If a nation’s currency was under attack from speculative sell-offs driven by a belief that the currency would be forced to devalue then capital controls could mute the flows of currency in the markets without leaving the central bank vulnerable to depletion of foreign reserves.

The use of capital controls was particularly apparent in maintaining the stability in the European Monetary System, the precursor to the Eurozone, in the 1980s (second-half).

The use of capital control were wiped out under the Single Market Act in 1987 and by the end of the 1980s currency instability increased within the EMS.

Of course, in this neo-liberal period, capital controls were eschewed and economists from the IMF down led the charge apparently ‘proving’ that they undermined growth and led to parlous outcomes for the country imposing the controls.

The Malaysian experience in the 1997 Asian financial meltdown demonstrated the folly of the IMF line.

More recently, Iceland, which I will come back to, imposed capital controls which helped it quickly overcome one of the largest banking collapses in history.

Even the IMF is now claiming that capital controls can provide beneficial outcomes and support growth.

I have written about capital controls before:

1. Why capital controls should be part of a progressive policy.

2. Are capital controls the answer?

When we talk of capital controls we are considering policies that aim to impose restrictions on the free movement of financial capital flows either into or out of the country or both.

A nation’s relationship with the rest of the world encompasses trade in goods and services, measured by the so-called current account of the Balance of Payments, and financial inflows and outflows which include loans and direct investment to productive firms and speculative purchases of financial assets and property, etc, measured by the capital account of the nation’s Balance of Payments.

Sometimes economists talk about capital account liberalisation to refer to policies that allow for increased flow of financial capital across borders.

The opposite is capital account regulation, which includes capital controls, The latter, typically, aims to place limits on the downward movements in the nation’s currency (to prevent inflationary surges) by preventing unproductive speculative financial flows which cause currency instability and reduce the foreign exchange reserves held by the central bank.

So the point is that even under flexible exchange rates, where markets are free to set the value of the nation’s currency against other currencies, capital controls can be used to isolate capital inflows. which aids the productive sector from speculative or ‘hot money’, which can undermine prosperity.

The reference to ‘hot’ money is important.

When economists claim that access to global financial markets and a broader array of investors can help a nation to develop they are typically referring to what we call Foreign Direct Investment (FDI) where a foreign investor provides funds to a productive enterprise in another nation.

This might take the form of building a factory, purchasing land for a firm to locate to, or providing plant, equipment, and skills to aid an firm.

Clearly, once this investment is in place, the notion of capital flight becomes difficult to sustain. Productive capital is in situ and as we saw in the case of Argentina in the early 2000s, if the owners walk away from the enterprise, workers can take control and continue producing if legal approvals are forthcoming.

We distinguish FDI from Foreign Portfolio Investment (FPI) which represents foreign investments in a nation’s financial assets which bear no interest in an underlying productive activity in the real sector of the economy.

FPI includes purchases of shares, corporate and government bonds, and other local currency-denominated assets which are typically easy to liquidate. Real estate is included in this category if held for speculative purposes, although it is less liquid than the array of financial assets that the ‘hot’ money is attracted to.

Clearly, this capital can be withdrawn very quickly and can be the source of financial instability.

There are virtually no benefits that arise from having unregulated ‘hot’ money flows.

Capital controls place a sort of ‘reverse’ discipline on the financial markets by forcing them to exhibit behaviours that support the government’s objectives in relation to its citizens.

The recent case of Iceland is instructive. Please read my blog – Iceland proves the nation state is alive and well – for more discussion on this point.

That small, open economy clearly proves that a currency-issuing state can resist the speculative damage that ‘hot’ money can cause if unregulated.

Even the IMF has now changed its opinion in the face of obvious empirical rejection of its previous ‘free market’ position.

In February 2010, the IMF released a research paper – Capital Inflows: The Role of Controls, IMF staff econmomists argued that under certain circumstances “capital controls … is justified as part of the policy toolkit to manage inflows”.

So we have two significant qualifications to the argument presented by the former Hungarian finance minister:

1. Why would any country want to peg their exchange rate? Which means that central banks and fiscal authorities have the capacity to set national policy to suit their objectives and can let the exchange rate take care of the external shifts.

2. The imposition of country-by-country capital controls can help eliminate the destructive macroeconomic impacts of rapid inflows or withdrawals of ‘hot’ financial capital.

I have argued in the past that the capital controls might only be a short-term fix. If we adopt a progressive view that the only productive role of the financial markets should be to advance the social welfare of the citizens then it is likely that a whole range of financial transactions, which drive cross-border capital flows, should be made illegal rather than controlled through capital restrictions.

In this context, capital controls may be an interim strategy while the nation sorts through the legislative tangle that would be involved.

So a nation that floats its currency (as all nations should) have complete discretion over what interest rate it sets.

And, if you understand that then it is obvious that if a nation wants to fix its exchange rate there will be negative consequences for domestic policy setting as the article in question notes:

The Czech, Polish and Hungarian national banks – all of these national banks have to adjust their interest rates in order to keep the exchange rate stable, which has nothing to do with managing the business cycle. No monetary policy, no interest rate policy can help economic growth under such circumstances.

This is exactly what is happening in Poland. So, I would be very happy to see a better argument but unfortunately the President of the Polish National Bank hasn’t provided any, opted instead for the unsubstantiated banality that it is a good thing to have monetary autonomy; the bad news is that Poland doesn’t.

But, the way in which the argument is set up is ridiculous. Poland CHOOSES the exchange rate regime in place for the zloty.

When it broke with the Communist system in the early 1990s, it immediately pegged its currency to the US dollar, thinking that would help with the inflation problem that beset all the old Soviet economies. The fixed exchange rate system failed badly.

By mid-1991 (May in fact), the government gave up, devalued the zloty, and tried a currency basket approach to the peg (abandoning the peg to the US dollar).

That failed too.

By October 1991, the central bank chose to abandon the fixed exchange rate regime and installed what is called a crawling peg – so a steady depreciation was built in to the peg.

That failed too.

There were a sequence of large devaluations introduced by the central bank as foreign exchange reserves became depleted.

By May 1995, the crawling peg became a crawling band (so fluctuations around the parity were allowed ± 7 per cent (a wide band).

The central bank abandoned that system in April 2000 as the zloty was floating within the band without issue.

Significantly, when the GFC hit, the zloty depreciated against the euro and the relative inflation rates meant that the Polish real exchange rate depreciated significantly.

Like Iceland, this is one of the major reasons, Poland avoided the GFC without entering recession. Indeed, it was the only EU Member State to avoid recession during the GFC.

So I find the comments by the former Hungarian Finance Minister strange. Both Hungary and Poland float their currencies which means they have all the monetary autonomy they like.

If they start using monetary policy to push or keep their currencies to one level or another then they abandon (by choice) that autonomy.

Simple as that.

The former Hungarian Finance Minister’s argument is that the central banks in Poland and Hungary are politically manipulated by the respective governments “in order to try to support export competitiveness”.

So his answer is to join the Eurozone and given up any notion of central bank autonomy.

The claim is that:

… the most important advantage of the euro is that the EU central bank is a much stronger institution than Hungary’s or Poland’s.

And at that point the nation loses its democratic freedom, just like 19 Member States within the EMU.

Apparently, the ECB is credible which is “very important for fostering sustainable economic growth”.

And that leads to “local economic policy … becoming much more rational and predictable, as a consequence, it would contribute to better growth.”

The usual neo-liberal lie.

The history of the Eurozone would not seem to support that contention.

The ECB has conspired with the European Commission and the IMF to create policy settings that have destroyed growth in the Eurozone.

The performance of the Eurozone is pathetic in terms of growth, unemployment, convergence of living standards to the highest and more.

The former Hungarian Finance Minister (in “devil’s advocate” mode) understands that.

He admits that the Eurozone does not have a viable “fiscal policy” and has “no democratic legitimacy” because the ECB is the only aggregate policy setting institution.

He says that:

That is a valid point, but it is not a good argument against joining the eurozone.

In trying to get through the inconsistency of his position he destroys his previous claim that the ECB is a beacon of stability and transparency.

He notes that during the GFC and after, the ECB has been:

… having this extraordinary relaxed monetary policy and purchasing all kinds of government and non-government bonds and debentures discounting even the closet paper … [and buying] … the bonds and debentures of insolvent sovereign states … is tantamount to a bailout which is applicable to Greece and also, to certain extend, Portugal.

And Italy and Spain and more.

So this beacon of stability is actually, in his eyes, a capricious, out of control, rule breaker – ratifying fiscal policies of insolvent Member States.

Which should be a good reason to avoid entering the Eurozone.

He then provides several reasons why the Eurozone should be disbanded although he thinks they are actually making the case for Hungary entering the EMU. Strange as that may seem.

1. The “eurozone is very fragile” but it “is still under construction – it is not finished yet”.

2. “one of the most important acts of national parliaments is setting the budget. And it is unrealistic to expect that those parliaments would give it up in the foreseeable future. So the national sovereignty is embodied in the fact that national parliaments create local fiscal rules”.

Which are overwritten by the Stability and Growth Pact (and related rules) imposed on the national fiscal positions by Brussels.

If a Member State tries to buck the system (as in Greece) the receivers are sent in, the ECB threatens to send the nation broke and the storm trooping Troika officials take over the country.

3. There should be a tightening “which would perhaps include also certain guarantees against excessive national debt”. That is, further restricting the scope of the elected Member State governments to defend their own nations from economic fluctuations.

These all represent arguments against joining the Eurozone.


The underlying argument driving the former Hungarian Finance Minister’s drive to join the Eurozone is that he doesn’t like (or trust) the current ruling polity.

So, in the end, it is just an ideological dispute and he thinks it would be better having policy determined in Brussels, Frankfurt and Washington and being unaccountable to the democratic process within Hungary.

The sad repetition of the standard neo-liberal line that democracy cannot be trusted so you need authoritarianism (disguised as the ‘free market’) to progress.

Hungary might be in the doldrums now – but just wait for what would happen if it was in the EMU and the neo-liberal authorities decided it was to be the next Greek lesson.

Crowdfunding Request – Economics for a progressive agenda

I received a request to promote this Crowdfunding effort. I note that I will receive a portion of the funds raised in the form of reimbursement of some travel expenses. I have waived my usual speaking fees and some other expenses to help this group out.

The Crowdfunding Site is for an – Economics for a progressive agenda.

As the site notes:

Professor Bill Mitchell, a leading proponent of Modern Monetary Theory, has agreed to be our speaker at a fringe meeting to be held during Labour Conference Week in Brighton in September 2017.

The meeting is being organised independently by a small group of Labour members whose goal is to start a conversation about reframing our understanding of economics to match a progressive political agenda. Our funds are limited and so we are seeking to raise money to cover the travel and other costs associated with the event. Your donations and support would be really appreciated.

For those interested in joining us the meeting will be held on Monday 25th September between 2 and 5pm and the venue is The Brighthelm Centre, North Road, Brighton, BN1 1YD. All are welcome and you don’t have to be a member of the Labour party to attend.

It will be great to see as many people in Brighton as possible.

Please give generously to ensure the organisers are not out of pocket.

That is enough for today!

(c) Copyright 2017 William Mitchell. All Rights Reserved.

This Post Has 13 Comments

  1. Dear Bill

    Let me just say that what matters is the real exchange rate, not the nominal exchange rate. A country could still aim to have a fixed real exchange even if it eschews fixed nominal exchange rates. It would then adjust its nominal exchange rate in light of the country’s inflation rate compared with the weighted average of the inflation rates of its trade partners. For instance, if Brazil has an inflation rate of 50% in a given period while the weighted average of the inflation rates of its trade partners in the same period is 20%, then at the end of the period the exchange rate of Brazil’s real should be 20% lower than at the beginning, 1.2/1.5 = 0.8.

    Just as fixed exchange rates are incompatible with unrestricted cross-border capital flows, so they are incompatible with unrestricted free trade. Let’s suppose that there are no cross-border capital flows at all. If a country really wanted to maintain its nominal exchange in such circumstances, it would have to start using import tariffs, export subsidies or export taxes to protect the nominal exchange rate. If it starts running trade deficits, it can use higher import tariffs and export subsidies to reduce the trade deficit. If it is having a trade surplus, it can lower its import tariffs or impose export taxes. After all, a devaluation has the same effect as a higher import tariff or an export subsidy, while an up-valuation has the same effect as a lower import tariff or an export tax.

    Regards. James

  2. Dear Bill,

    Let me mention that Poland is in total mess because the ruling party (“Law and Justice”) went after the so-called separation of powers, trying to replace the Supreme Court judges etc. The president (who is from the same party) vetoed 2 out of 3 bills. EU commission is threatening with steps which would eventually lead to Poland leaving the EU.

    The current climate of insanity had reached its climax a few days ago before the bills, still full of mistakes, were voted. The chairman of the ruling party Jarosław Kaczyński seized the parliament’s lectern and accused the opposition of murdering his twin-brother president Lech Kaczynski (who died in a plane crash in Smolensk in 2010 when the pilots, pressed by the chief of the air force who was in the cockpit, made an attempt to land the plane in a thick fog and crashed)
    “Do not wipe your traitorous mugs with the name of my late brother. You are scoundrels. You murdered him”
    (Previously they accused Putin of creating artificial fog. This is not a joke, this is far more insane than all the stuff Donald Trumps supporters have ever been able to invent)
    The current political discourse in Poland is much closer to leaving the EU and writing a new catholic-fascist constitution than adopting the Euro. But we should not be too concerned, the ruling group will most likely self-destruct and the catholic hierarchy parasite will find another more neo-liberal host. The well-preserved Polish aristocratic tradition of brawling has about 400 years. The infighting has already started.

  3. James,

    Your import tariff / export subsidy idea merits consideration. Heiner Flassbeck suggested that as a solution for Greece and coincidentally I published the same idea on the same day as Flassbeck on my own blog.

    A problem with import tariffs is that it’s a kind of “last chance saloon”. I.e. any country adopting that solution must continue to keep a lid on wage and price increases so as to eventually regain competitiveness.

    Another problem is that tariffs are exactly what the EU is designed to do away with. On the other hand desperate times call for desperate solutions.

  4. I suspect that a badly negotiated Trade in Services Agreement could have the same effects as a fixed exchange rate. It could prevent local regulation, and create a system of rigid rules that the hot-money players could game.

  5. Regarding direct vs portfolio investment: When people make direct investment, they expect that they will be able to get their money back at some time in the future. Portfolio investment increases the likelihood and decreases the time for this to occur, which serves to increase the value of such direct investments and thereby make people want to make the investment.

    Therefore, restricting portfolio investment will also restrict direct investment. That’s not to say that there might not be a benefit of restricting portfolio investments; it’s just that there may be unintended consequences.

  6. Your articles are very well thought out and well written. But sometimes a bit too long. This one, for instance, could have been rewritten much more effectively:

    The prime argument presented by this author is that they should join the Euro because as small and open economy with unrestricted cross-border capital flows and a fully convertible currency, we cannot influence both the exchange rate and interest rates at the same time. If we joined the Euro, we (through the ECB) could do this.

    Let’s be clear on this from the outset. No nation of any size that has unrestricted cross-border capital flows can fix its exchange rate against other rate(s) and then expect to be able to be able to set interest rates. This is obvious from looking at the Euro since inception, or even the US over the last 40 years. If even these largest can\’t do it, then the prime benefit he espouses is proven false. He then lists a bunch of negative consequences. With his prime benefit is proven false, all you are left with is an article that does a good job of describing why a country should not join the Euro.

  7. Which is Ralph Musgrave allowed to post here? Applying minimal standards of quality control and human decency ought readily to result in him being permanently and irrevocably banned from posting.

    In addition to being a fascist, reactionary twat, he consistently peddles complete nonsense on a substantive level.

  8. Steve,

    I suspect Bills defence will be the Churchillian one.

    The blogs are long because he hasn’t got the time to write a short one.

  9. Bill –
    Do capital controls have any genuine advantage?
    Or do they just appeal to your contrarian instinct?

    And why the economic wowserism?
    MMT enables governments to respond to any situation, so why do you want to restrict people’s freedom to do what they like with their own money?

  10. “Do capital controls have any genuine advantage?”

    Why do they put brakes on trading on stock exchanges? Why would you want to restrict people’s freedom to do what they like with their money?

    It’s about managing the dynamics in the marketplace. If you have wild swings, just the information delay can cause systemic failure. That’s standard knowledge about how a balancing loop with delay works.

  11. “The blogs are long because he hasn’t got the time to write a short one.”

    That was my excuse for my PhD thesis, handed in 3 hours before the official 4 year submission deadline, when my external examiner complained how long it was. In fact technically it was over the nominal 80,000 word count limit, but as this was pre-electronic submission, I just made up the number included in the cover slip (79,938 coveniently) guessing that no-one could go through and count every word. Sound economics you might call it.

  12. great blog,its ludricous how ill advised these high politically influential people ideas are

  13. Neil –
    Why indeed? I’m not convinced that suspending trading on stock exchanges actually does any good.

    It’s not information delay that causes systemic failure, it’s lack of adequate reinsurance.

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