Yves here. This post drills into some of the claims made about the advantages of France leaving the Eurozone, as in a Frexit, and finds many of them wanting. Reader input and reactions are very much encouraged.

From my vantage, author Grégory Claeys needs to get up to speed on Modern Monetary Theory. His third concern, regarding how much deficit spending France could do, is based on the misapprehension that France would need to borrow to run deficits. He’s thus managed to miss the big point of exiting the Euro: as a monetarily sovereign nation, French deficit spending would be limited by the need to avoid generating too much inflation, which in turn reflects how much demand needs to be created to employ otherwise slack resources.

The flip side is his final point focuses on the economic dislocation of a Frexit. As we, aided by many bank IT experts, in particular Clive but also seasoned members of the commentariat, have stressed, the technology implementation of a new currency is a very long lead time process due to the fact that:

1. There is tons of code involved, including lots of legacy code that can only be inspected and changed line by line 2. There are numerous parties involved. Any task requiring coordination is far more cumbersome and time consuming than one that can be accomplished internally 3. Banks are already very thinly staffed in their IT areas and the guys who know their way around the legacy code have been and are continuing to retire, which does not bode well for banks and other financial players being able to mobilize enough resources even if they decided to throw a lot of budget dollars at it

By Grégory Claeys, an Associate Professor at the Conservatoire National des Arts et Métiers in Paris where he is teaching macroeconomics in the Master of Finance. He previously taught undergraduate macroeconomics at Sciences Po in Paris. Originally published at Bruegel

A debate is raging in France about the benefits and drawbacks of the Euro. The argument echoes that of the first half of the 1990s – between those in favour of joining the Euro and those against. However, the parallels are misleading and should not inform today’s debate. The Euro has been the official currency of France for almost two decades now, and exiting it would be very different from choosing not to join in the first place. In this blog post, I expose five myths about the supposed benefits of Frexit.

Myth 1: Frexit Would Unambiguously Boost French Competitiveness

Advocates of leaving the Euro claim that Frexit would provide a competitiveness boost to French exports and essentially solve two alleged problems: the persistent trade deficit and the decline in market share for French goods, especially compared to Germany (see graphs below).

Indeed, in theory, a flexible exchange rate provides an automatic adjustment mechanism to correct external imbalances. It plays the role of a shock absorber for country-specific shocks and allows countries to quickly improve their price competitiveness. And a nominal devaluation should be easier and less painful to achieve than an internal devaluation inside the Eurozone, which would requires a period of lower inflation and wage growth than euro area partners.





First of all, these two problems are largely exaggerated. The decline in export market share since 2000 is not specific to France and is actually the norm across industrialised countries. It is the result of China and other emerging countries joining the global economy. Germany’s stable share is actually an outlier in comparison to other advanced countries. As for the French trade deficit, it has in fact slowly decreased over the last 5 years and its current level (-1.3%) is not a concern.

In addition, the Euro has weakened over the last two years due to the accommodative monetary policy of the ECB. And this has already provided a significant boost in terms of price competiveness. Since mid-2014, the Euro has depreciated by 25% against the US dollar and it cannot be considered overvalued for the euro area as a whole.

In fact, the main issue comes from imbalances within the Eurozone. According to a recent estimation, France is, in real terms, overvalued by 7% with respect to the Eurozone average and by 20% with respect to Germany. A new French currency (let’s called it the Franc for simplicity) would thus probably depreciate against the Euro after its introduction.

At first glance, recent estimations suggest that the French imports and exports are sensitive to price shifts[1], so a nominal depreciation against the Euro would help France improve its trade balance after a few years. Indeed, I am not denying the powerful effects of exchange rate fluctuations on the trade balances (as confirmed again recently in an IMF paper). However, for the effects of a depreciation to be beneficial and long-lasting, inflation needs to be contained and therefore monetary policy needs to be credible to avoid a dis-anchoring of inflation expectations. Otherwise, the inflation spike resulting from a sudden increase in import prices can lead to second-round effects through an upward adjustment in wages and other prices which gradually erode the gains from the nominal depreciation.

Equally important, if France were to leave the Euro, it could be followed by others. In that case, the Franc would depreciate against northern European currencies, but it would probably appreciate against new currencies from Southern Europe. Looking at France’s main trading partners, it is true that Germany represents by far the most important single export market for France – 16% of French exports. But Southern Europe as a whole amounts to a similar percentage.

Given the current sectoral specialisation of French industry, an increase in price competition resulting from an appreciation of the Franc against southern currencies could end up being more detrimental for the French trade balance than the benefits of the depreciation against the currencies of Germany and other Northern countries.

So, overall, it is true that a flexible exchange rate is a helpful adjustment mechanism to absorb temporary shocks and to reduce external imbalances, if combined with a credible monetary policy framework. However, France does not really have an overvaluation problem relative to the rest of the world and within the euro area the country is not very far from the average. Supposed gains in terms of price competitiveness would thus be much less significant than what Frexit supporters suggest.

Myth 2: Frexit Would Lead to a More Appropriate Monetary Policy

Another major benefit promised by Frexit advocates is an independent monetary policy tailored to the domestic economy and not to the Eurozone average. This argument is valid in theory, but in practice it is once again not relevant for France. France is generally well represented by the Eurozone average because its economy behaves like the average of the euro area. For instance, the interest rate prescriptions provided by simple Taylor rules (see graph below) for France and the euro area are very similar. This suggest that monetary policy decisions made by an independent Banque de France following a mandate similar to the ECB’s would not be so different than the ones taken by the ECB governing council.

Source: Bruegel based on Eurostat, AMECO, Fries et al. (2016), Holston, Laubach and Williams (2016).

An exit from the monetary union could actually make French monetary policy more difficult, especially in the short term, as it might lead to an increase of inflation to undesired levels. Not only would the Franc depreciate, but the experiences of countries abruptly changing exchange rate regimes suggest that some overshooting would take place beyond what fundamentals require.

Depreciations make imports more expensive, and past episodes of rapid currency depreciation (see table below) suggest an immediate surge in inflation. Given the importance of imports in some key sectors in France (energy in particular), a strong depreciation of the Franc would have a negative effect on the economy in the short term and would (at least) lead to a temporary spike in inflation.

To ensure that the spike is only temporary, a credible monetary framework would need to be established quickly. This is, however, incompatible with other policies advocated by the partisans of Frexit, who also want to deprive the Banque de France of its independence and authorise direct financing of the government by the central bank. This appears especially incoherent with the promise by Frexit advocates to keep inflation low after leaving the Euro.

Frexit advocates want to get rid of the Euro to boost French exports, but paradoxically they are also sceptical towards a fully flexible exchange rate regime because they fear excessive volatility in the foreign exchange market. In fact, general public support for flexible rates has always been relatively weak in France. That’s why some Frexit partisans are pleading for the return to the ECU and to the European system of fixed exchange rates that was in place before Maastricht. It is strange to want to leave a common currency only to bind yourself to another currency in a fixed exchange rate system.

Even putting aside this paradox, pegging oneself to a foreign currency requires policy credibility to achieve exchange rate stability. Monetary sovereignty under such a system is in practice illusory because the Banque de France would have to adjust its policies to defend its parity and thus adapt its interest rates in reaction to its neighbour’s cyclical situation (be it the Eurozone or Germany) [2]. In this case, the current shared sovereignty in the Governing Council of the ECB appears preferable in terms of macroeconomic policy performance, as well as sovereignty.

Myth 3: Frexit Would Relax Constraints on Fiscal Policy

Frexit partisans suggest that leaving the Euro could free the country from the constraints of European fiscal rules and allow the French government to pursue a more countercyclical fiscal policy. But countercyclical fiscal policy doesn’t seem to be a French speciality anyway, and leaving the Euro could damage France’s credibility, making it difficult to borrow the money needed for counter-cyclical spending.

As the graph below shows, over the last 17 years, French fiscal policy has only been countercyclical in 2006 and 2009. The rest of the time fiscal policy is mainly procyclical. In good times the government increases spending or cuts taxes, even if this drives GDP further above potential. In bad times the government increases taxes and cuts expenditures, even if growth is negatively affected.

Figure 4 – Fiscal stance in France