Farewell, then, Estonian kroon. Born: Jun. 20, 1992. Passed away: Dec. 31, 2010.
With the new year, Estonia becomes the 17th country to adopt the euro. An inauspicious move, some including Paul Krugman and Nouriel Roubini say. This point of view, some argue, has been reinforced by the turmoil in the euro zone over the past year. Such critics say that far from joining the euro, the country should devalue.
For its entire life, the kroon has been pegged in a currency board-type arrangement to the German mark and then to the euro. (In its earlier incarnation, from 1928 until the Soviet invasion in 1940, it was linked first to gold and then to the British pound.)
In 1992, the year the kroon was (re)introduced and the ruble abandoned, inflation was 1,076.5%. (The central bank in Moscow was printing money to fund the government.) A currency peg helped subdue inflation though it later helped to foster a bubble and financial crisis.
What now for Estonia? Here in his obituary for the currency, Fredrik Erixon of the Brussels-based European Centre for International Political Economy argues it’s mostly good.
“For a small country like Estonia, with less than 1.5 million inhabitants, a floating currency is not really a safe choice. It has indeed worked well for a transition country like Poland. But Estonia is not Poland. Estonia’s financial market is too illiquid and unstable for outsiders to do business in the local currency. Inevitably, the interest rate would have to follow the dominant actors in the region – the European Central Bank of course being the central actor.
“Moreover, Estonia’s trade sector (trade-to-GDP) is bigger than in most other countries, and has hovered around 160 percent in the past decade. By comparison, the size of Poland’s trade sector in 2008 was 84 percent. For a small and trade dependent country, there are benefits with sharing the same currency as your major trading partner. And Estonia’s major trading partners are in the Eurozone. At least one third of Estonia’s total trade is with euro members (Sweden is the second biggest trade partner, representing around 13 percent of Estonia’s total trade) and the figure is likely to increase as some of the big trading partners – like Latvia and Lithuania – are likely to join the euro in a few years.”
Joining the euro won’t be without problems, however. Estonia is a long-time fiscal hawk: Budget-cutting seems to be easier there than in places like Greece. But one big risk will be a future Ireland-style asset price bubble.
“(T)he future problem for Estonia is likely to be the greater need to cool its economy and credit expansion compared with other euro countries. Estonia is likely to return to high growth in a few years time. In contrast to what many members of the economics cognoscenti believed, Estonia did not go through an Argentinean-style fiscal crisis. Its crisis was not about deficits and an unsustainable build-up of debt. The crisis rather resembled the Asian financial crisis in the late 1990s. The economy (the private sector) overheated and the authorities (and banks) could and would not stop asset values (especially property) to morph into a giant bubble. The crisis was financial, not structural, in nature. Hence, there are good reasons to believe that Estonia has a bright economic future.”
“Euro membership will actually give Estonia some new flexibilities, but the effects of them will be marginal. Its ability to avoid another cycle of boom-and-bust will be defined by its domestic economic and regulatory policy.”