Deglobalisation post COVID-19 could spell trouble for the European Monetary Union

Less integration would make it difficult for the ECB to stabilise the euro area economies, and individual countries would need to use fiscal policy tools, write Akvile Bertasiute, Domenico Massaro and Matthias Weber

The COVID-19 crisis led to severe restrictions in mobility across borders, concerning both individuals and goods. Borders were closed, international travel made almost impossible, and final and intermediate goods were unable to get from one country to another. Massive disruptions of global value chains were caused by inputs not being manufactured due to lockdowns or not being delivered.

While the situation is improving, it is not clear what the long-run economic consequences of the pandemic are. Firms might, for instance, rely more on the production of inputs within national borders to be prepared for similar situations. Such hedging of risks might come at the expense of productivity, as most economists are aware. In addition, such a re-nationalisation or de-globalisation could interfere with monetary policy in the euro area and severely trouble the functioning of the monetary/currency union, which is not well known.

We show why this is the case in a recent research article. We use a dynamic macroeconomic currency union model to analyse how a currency union is affected by the interconnectedness of the countries and how this interacts with monetary policy. We analyse the model not only with rational expectations but also with a variety of behavioural expectations, as rational expectations have many times been attacked for their lack of realism. Which varieties of behavioural expectations we use is described further below – our main results hold up with behavioural and rational expectations alike.

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