You Don’t Buy a Cow to Get a Glass of Milk

Firstly, the phenomenon of a local currency weakening in response to a negative shock is natural and desirable in equal measure, one of the key arguments in favour of preserving local currencies. Currency exchange rates function like a shock absorber, facilitating relatively painless economic adjustments while softening the impact of the destabilised environment. Secondly, the weakening of the zloty against the euro has been rather limited, given the scale of economic shock and geopolitical risk. On average, the zloty/euro exchange rate dropped by a mere 3 percent this year over the previous year; even during the market panic peak, the scale of the zloty's depreciation against the common currency did not exceed 10 per cent compared to pre-war levels.

This scale of local currency weakening carries no essential negative macroeconomic implications. In particular, it does not significantly hinder the struggle against high inflation rates. Available estimates suggest that sustained weakening of the zloty by 10 per cent would increase the inflation rate by 1-1.5 percentage points. It can thus be concluded that average annual depreciation of the local currency against the euro by a mere 3 per cent would contribute no more than half a percentage point to the inflation rate. One might point out that the effective exchange rate of the zloty had been weaker, mainly given the currency’s depreciation against the dollar. Yet this was the outcome of the euro weakening against the dollar, which in turn translated into the zloty depreciating against the US currency. Poland adopting the euro would not be a relevant safeguard against this.

NATO, not Euro

Does paying in euro rather than the local currency make one invincible? Does eurozone membership offer defence against military aggression? While this is not, strictly speaking, an economic matter, even an economist knows that the answer to these questions is “No”.

In this particular case, it makes sense to focus on the strongly pro-European yet pragmatic Nordic states. A long-standing presence in the eurozone, Finland decided that this in itself was not a sufficient “guarantee” of security, and decided to join NATO in defiance of its long-held neutrality. Faced with the threat of Russia's imperialist aspirations, Sweden, too, found it expedient to relinquish neutral status, making a swift and immediate decision to join the North Atlantic Alliance. Nonetheless, it is noteworthy that the country did not concurrently engage in any discussion regarding the euro. Could it be that the pragmatic Swedes have been underestimating the importance of the common currency to national security?

Furthermore, it is notable that the process of joining the eurozone may limit a state’s defence capacity. Meeting the Maastricht criteria is tantamount to domestic macroeconomic policy “rigidity” over a few years, including relatively restrictive monetary and fiscal policy measures. This would prevent swiftly or significantly increasing defence spending, which in Poland’s case seems an objective necessity, given the existential threat of Russian aggression. The position manifestly taken by the two largest eurozone member economies in the early days of Russia’s aggression offers no robust guarantee that adopting he common currency stands for security.

Common Currency Does not Warrant SuccesN

New arguments in the aftermath of the war in Ukraine change nothing in terms of assessing the cost-to-benefit ratio of adopting the euro. Over 20 years old today, the eurozone’s history is not an unblemished string of success. Recent decades of enduring crisis-related shocks and painstaking efforts to restore post-crisis equilibrium in the eurozone have served to confirm uncertainties concerning the bloc’s imperfect structure.

The eurozone’s issues have remained unresolved. Excessive debt incurred by multiple member states, including Italy – the third largest eurozone economy – makes it very difficult for the European Central Bank to respond to current runaway inflation, among others. Driven by concerns regarding the condition of structurally weak member states, the process of raising interest rates has been severely delayed. The ECB approved the first interest rate increase only in July 2021, over one year later than the Central and East Europe (CEE) region, nine months after the process of monetary policy restrictions had been initiated in Poland. In addition, the process of raising interest rates in the eurozone had to be preceded by the introduction of a special-purpose mechanism protecting “weak links” against an excessive upsurge of debt service expenses.

The spread of inflation rates across eurozone member states has reached around 20 percentage points, and CEE is the region with the most acute price increases. This is ample proof that while inflationary shock associated with the Russian aggression driven energy crisis has affected all European economies, the degree of impact varies and the shock is therefore asymmetrical. This automatically gives rise to the question whether – given current conditions – the struggle with inflation in Poland would be easier and more effective if it were waged by the European Central Bank ECB instead of the National Bank of Poland. It is highly unlikely. In this context, one might conclude outright that the new circumstances arising from the war in Ukraine reinforce arguments against hasty adoption of the euro.

Poland’s Sound Bottom Line Requires Discipline

Struggling with grave dysfunctionalities, the eurozone is no guarantor of macroeconomic stability. This requires hard work in the form of proper macroeconomic policy and activities aimed at building sturdy and healthy foundations for a highly competitive economy. Poland’s economy is performing very favourably in this regard. Significantly reduced foreign debt and an improved international investment position; perpetually low increases in unit labour costs in contrast to competing economies; a sound balance of payments condition benchmarked against the region’s major economies; a fiscal deficit among the lowest in the EU; little public debt; limited private sector leverage; no excess loan boom over a number of years (with a decline in the credit-to-GDP ratio over recent years); real interest rate levels matching the EU median: these are not the characteristics of an economy that is vulnerable to crisis within or beyond the eurozone. Poland came out ahead of all European Union economies in the European Commission’s most recent Macroeconomic Imbalance Procedure for 2021. With only one imbalance recorded, the already available 2022 data indicate that it has been eliminated. Poland’s economy was in the lead of the Macroeconomic Imbalance Procedure ranking in previous years as well.

It should be emphasised that remaining outside the eurozone requires greater macroeconomic policy discipline in order to preserve a similar measure of resilience to global external shocks. As part of the eurozone, one can count on greater leniency, as well as the ECB’s interventionist asset purchases and other “anti-crisis” measures. Staying out means one is forced to adopt better macroeconomic discipline or doomed to pay a higher risk premium under shock conditions – or struggle through currency crisis under a black scenario. Without a healthy, competitive economy or macroeconomic stability, the state’s proprietary currency can become a catalyst of crisis rather than an effective adjustment mechanism.

Benefits of Remaining Outside The Eurozone

It is noteworthy that while not a common currency member state, Poland enjoys most of the benefits related to the eurozone, which stretches across the vast majority of the EU market. Managing the exchange rate risk for a single exchange rate against a common currency is far less costly than the same process for 20 currencies. Moreover, eurozone member states are not in a position to increase their competitiveness against Poland’s economy through discretionary devaluation or market depreciation of local currencies. For these reasons, Poland has been able to recently increase its trade volume with Germany much more and at much higher levels than France – a country at the heart of the eurozone, and Germany’s close neighbour as well.

Adopting the euro is no formula for success. Under current circumstances – prevailing dysfunctionalities in the eurozone, multiple asymmetrical shocks affecting European economies, and Poland’s considerable macroeconomic stability – replacing the zloty with the euro in the foreseeable future does not seem the optimal choice. Yet the field for manoeuvre in Polish macroeconomic policy is significantly limited with no room for breeding “twin deficits”. In the aftermath of drastic monetary policy restrictions (the highest and swiftest interest rate increases the National Bank of Poland (NBP) has introduced for over 20 years), the key role goes to fiscal policy. Even a moderate rise in fiscal deficit may prove a challenge in conditions of blatantly tight financial conditions worldwide (the end of an era of inexpensive and easily accessible money). In such a context, access to European Union funds becomes crucial. Access to tens of billions of euros in EU funding is becoming more important than ever before in terms of preserving macroeconomic stability and investor confidence. An influx of EU money would make it much easier to proceed with significant risk-free market investments of strategic importance to Poland, including energy transformation and defence projects. Paradoxically, Poland’s closer ties to the EU are conducive to keeping the Polish economy outside the eurozone. ©℗