No more euro introductions likely – for now

In the latest Nordea On Your Mind report, "The euro in the Nordics 2.0," Johan Trocmé interviews four of Nordea's most senior macroeconomists: Helge Pedersen from Denmark, Annika Winsth from Sweden, Juho Kostiainen from Finland, and Kjetil Olsen from Norway.

Finland is broadly content with the euro. Denmark may adopt it in the end, but not anytime soon. Norway's macro cycle is different from that of the EU, and using the euro and EU monetary policy could do more harm than good. Sweden has some frustration over the SEK weakness, which is not boosting the economy as broadly as in the past, but may need to see it get substantially worse for any reconsideration of the euro to gain real political impetus.

Johan Trocmé (JT): What prompted Finland's strong support for EU membership in its referendum of 1994, and the subsequent support for and eventual adoption of the euro? 

Juho Kostiainen (JK): Finland's journey to the euro, and then with the euro, has not been entirely smooth. There has been a recurring discourse on the merits of the euro. The first occasion was after the global financial crisis in 2008-09, which hit Finland particularly hard. Potential shocks to the Finnish economy were highlighted as a risk prior to the adoption of the euro in 1999. Finland did not suffer as badly as, for example, Greece, in the aftermath of the financial crisis, but we did have country-specific problems arising from the demise of Nokia as the the world's biggest mobile phone maker, and issues in our manufacturing sector. It was unfortunate that we reached quite a generous wage agreement between employers and unions at the worst possible time, when demand had started to crash. We were still in the process of learning how to set wages as a member of the euro area. The labour market had not quite rid itself of its historical mindset of a local currency being able to come to the rescue during a shock to the economy, and depreciate to restore competitiveness. And in the post-crisis environment of very low inflation, it was a painful experience when it took many years of Finnish real wages staying flat in order to adjust to the lower demand. We have learned from this, and are currently not leading wage demands in the euro area. 

During the eurozone crisis in 2011-12, with first bilateral and then EU and ESM loans to struggling members, there was a heated debate in Finland in which populist political parties gained a lot of traction for the argument against a fiscally disciplined eurozone country like Finland footing the bill for the lack of fiscal prudence by other members. This discourse cooled off when the eurozone crisis dissipated, and did not really flare up when new EU support packages were introduced during the COVID pandemic, as this was considered very different and much less controversial.

Generally, I think the Finns are quite happy about the exchange rate stability brought about by the euro. I am not aware of any major study decisively proving that it has been a big benefit or disadvantage for Finland to use the euro as its currency. But it has certainly removed an element of uncertainty in corporate planning, and added convenience for private citizens in, for example, travel and international purchases.

One more recent challenge for Finland related to the euro is that the ECB interest rate hikes are hurting mortgage borrowers more than elsewhere in the EU. Finnish mortgages predominantly have variable interest rates, versus ten- to 30-year fixed rates in many big European countries. You could say this makes today's euro interest rates seem a bit high for Finnish borrowers, even if they seem appropriate, or at least okay, among other EU members.

JT: What has been the Finnish experience with the euro since its introduction in 1999? Any regrets? Any debate? Perceived benefits or problems? 

JK: Finnish large corporates tend to make noise about FX headwinds at times when exchange rates reach what are seen as extreme levels. For example, in the past couple of years, and during the global financial crisis in 2008-09, the SEK weakness has triggered remarks about the competitiveness of the Finnish paper and forestry industry. But most of the time, in a normal FX environment, this conversation is quite muted.

JT: Has a floating SEK worked as an insurance or cushion against country-specific macro shocks since 2003? If not, or not so well – why?

Annika Winsth (AW): I think the answer is "yes and no". There are pros and cons with a floating currency. Being able to conduct your own monetary policy and having flexibility in terms of wages and prices can be very helpful for the economy. And on the other hand, a stable exchange rate versus your key trading partners is a major benefit. The weak Swedish krona during the global financial crisis did offer a cushion which softened the blow to the Swedish economy, not least relative to euro countries such as Finland. And this was also the view of Anders Borg, who was Sweden's finance minister at the time.

But since the Swedish referendum rejecting the euro in 2003, a lot has changed. Globalisation of the world economy has soared, particularly since the entry of China into the WTO in 2001. Corporate supply chains have become more global and more complex. The Swedish economy has become even more dependent on other countries, and potential shocks and risks are typically more global in nature, as we have seen, for example, with the COVID pandemic and Russia's invasion of Ukraine and the subsequent European energy crisis. It is not always easy for a small country like Sweden to deal with these kinds of challenges or threats, and it helps to have friends, partners and allies – as evidenced by Sweden's application to join NATO. Adopting the euro could be one possible such step towards closer ties with partners.

We need to be mindful, though, that it is not up to Sweden at what exchange rate it would be able to replace the krona with the euro. A positive scenario for Sweden might perhaps be a level of SEK 10.50 per euro. But at that level, major Swedish exporters might complain and voice opposition to adopting the euro. The new Swedish discourse on potentially adopting the euro started to heat up when the exchange rate approached SEK 12 per euro. But I think it was often based on some belief that the SEK weakness could be solved by introducing the euro, and that it would be very much up to Sweden at what exchange rate it would take place. In reality, this would, of course, be subject to negotiations between Sweden and the eurozone members. It is hardly likely that the current eurozone members would let Sweden adopt the euro at an exchange rate which would benefit us at their expense. If anything, they might negotiate for the opposite.

Another important point is that a potential adoption of the euro would ultimately be a political decision. It is not only about an economic cost-benefit analysis, but also about political ideology and positioning.

JT: How much independence from the ECB in terms of monetary policy does Sweden in reality have with a floating SEK?

AW: Not that much. The Swedish Riksbank has some room to deviate from the ECB with policy measures, which we have seen recently, Swedish policy rates were lower than the ECB's despite a stronger economy. But the ECB very much sets the tone for Swedish monetary policy, given the EU's importance as our biggest trading partner.

JT: What could make Sweden reconsider the euro again?

AW: I think it may require a scenario with a perceived urgency similar to the Swedish NATO membership issue, where the new potential national security threat from Russia's behaviour in Ukraine upended the historical views on Swedish neutrality held for decades across the political spectrum. The krona would likely have to weaken very sharply to trigger real pressure for adopting the euro. We had a discourse when we reached SEK 12 per euro. That was not enough for any serious consideration to be given to ditching the krona for the euro. I would not rule out a new discourse emerging should we get to SEK 13 or SEK 14 per euro. It could lead all the way to a government proposal and a parliamentary vote, but I doubt that we will get to that point. And it is impossible to predict today what exchange rate would need to be reached in order for this to happen. At present, adoption of the euro in Sweden is not a general election winning issue, and there are so many other pressing issues for our politicians to deal with. The biggest impetus for the euro issue in Sweden would come from the corporate sector. Importers such as retailers are struggling due to the weak krona, and have an incentive to argue for the euro. But exporters – who have historically got the most attention from policymakers – play a bigger role in the Swedish economy. And for them, a scenario of replacing the krona with the euro at an exchange rate of 10.50 may not be appealing at all. I don't believe Sweden will move any closer towards adopting the euro in the short term.

JT: Denmark has never had a fully floating exchange rate – why is this? Has the experience with ERM I and ERM II been perceived as good? Has a floating DKK been considered?

Helge Pedersen (HP): Indeed, Denmark has no tradition of a fully floating exchange rate for the Danish krona, even going as far back as the gold standard in the late 19th century. The objective has mainly been to maintain as stable exchange rates as possible against Denmark's main trading partners, to in turn create a stable business environment for Danish businesses and households. This aim of exchange rate stability has been tested many times over the years, not least with regards to Sweden, which used to be Denmark's second most important trading partner after Germany. But throughout multiple Swedish devaluations under previous fixed exchange rate regimes in the 1970s and 1980s, and the floating Swedish krona since 1993, Danish policymakers have stuck to this approach.

I think it is fair to say that the fixed exchange rate for the Danish krone is well anchored and appreciated, both by corporates and households. Private citizens have that same visibility and convenience which Juho mentioned for Finland, regarding travel and international purchases. Corporates have good pricing visibility for both exports and sourcing from their international supply chains, which helps their business planning and investment decisions. There is no real debate about currency in Denmark today. There seems to be a strong consensus that the current approach is a good one.

JT: What are the arguments for retaining the DKK instead of actually introducing the euro? Is there any point in maintaining the DKK when it is bilaterally pegged against the euro?

HP: The way I would describe it to you would be as an emotional issue. On 2 June 1992, just before Denmark won the European Football Championship after defeating Germany in the final in Gothenburg, Sweden, a referendum on the Maastricht Treaty and the future common currency was held. When the referendum rejected the treaty, all the major political parties sat down and negotiated a national compromise, stipulating what specific opt-outs for Denmark should be agreed with the EU if the treaty was put to a new referendum. Ultimately, Denmark negotiated four opt-outs with the EU, after which the – modified – Maastricht Treaty was approved in another referendum in 1993. One of these was to retain the Danish krone instead of adopting the euro. The issue was tried again in a new referendum in 2000. The political establishment was quite broadly in favour of adopting the euro, recognising that there were no material policy benefits from retaining a tightly pegged DKK. Entering the eurozone was seen to offer Denmark at least some say on EU monetary policy, rather than being a pure follower. But the euro was again rejected in the 2000 referendum, and since then there has been no new attempt to challenge the status quo.

The currency has so far been seen by the electorate as an issue to do with national sovereignty, irrespective of the fact that the peg to the euro de facto means that Danish monetary policy is set by the ECB. It is not about common sense. As I said, it is more of an emotional issue. To be fair, I think there is an argument that opting out from the euro has contributed to strengthening Danish fiscal discipline for government spending even more, with seven consecutive years of budget surpluses now and among the lowest government debt to GDP ratios in the EU. And at present, Danish central bank policy interest rates are slightly below those of the ECB, and Danish government bond yields have almost a zero premium to similarly rated eurozone government bonds. This is in contrast to some concerns voiced when the euro was first introduced in 1999, that there would be a price to pay for Denmark for staying outside the eurozone. I would say that good Danish economic governance since then has proved those concerns wrong. And just as a reflection, the Danish experience suggests other countries could replicate the approach of joining ERM II and peg their currencies to the euro, it they are willing and able to pursue good economic governance.

JT: What could change Denmark's view on the euro? 

HP: If Sweden had voted "yes" to introducing the euro in its 2003 referendum, I suspect Denmark might have followed suit with a new referendum and ultimately have gone down the same route. I think most Danes in this kind of context tend to see the Nordic region or Scandinavia as their frame of reference, rather than the whole of Europe. What our neighbours are doing carries more weight than what we see across Europe.

I followed the Finnish discourse at the time of its EU membership referendum in 1994 quite closely, and my impression is that national security was for Finland also a relevant factor in seeking both EU membership and subsequently becoming a eurozone member by replacing its markka with the euro. There was no such discourse in Denmark, which was already a NATO member when it joined the EU back in 1973. But after Russia invaded Ukraine, Denmark held a referendum which led us to abandon one of our four opt-outs from the Maastricht Treaty, the one regarding the EU's common defence policy. So, national security has clearly affected the status of Denmark's EU membership, but not our currency.

I don't think the Danish krone is a holy grail. Should circumstances change significantly, I think Denmark could reconsider its stance. It could to some extent also be a generational issue. New generations have grown up with and become accustomed to the euro, giving them a different perspective. I think a new euro referendum in Denmark is unlikely in the next five to ten years, but certainly a possibility ten to 20 years from now, if the euro remains a robust major currency.

JT: Norway would presumably need to become an EU member to even consider adopting the EUR, but could pegging the NOK to the euro be considered? Would this even make sense for an economy that is quite different to Europe's?

Kjetil Olsen (KO): At present, I think it would be wrong for Norway to even consider adopting the euro, as there are good economic reasons for having a floating currency. This may well change in 30-40 years, but today the Norwegian economy is heavily biased towards raw materials, particularly the oil and gas industry. This makes Norway's economy quite different to that of the EU, and those of most European countries. The macroeconomic cycle for Norway is very often out of step with the European cycle. At the time of the eurozone crisis in 2011-12, when the EU economy was suffering, Norway was in a boom. In 2014-15, Europe was doing well, while Norway suffered badly from a shock caused by a plunge in the oil price.

This asymmetry versus Europe makes the euro unsuitable as a currency for the Norwegian economy. European monetary policy could often be counterproductive for the economic conditions in Norway. In addition, the floating currency – the Norwegian krone – acts as a buffer when the Norwegian economy suffers a shock. We saw this both in 2011 and in 2014. Norway was able to adjust to a great extent through the exchange rate for the krone, rather than making the entire adjustment through wages. Putting it another way, Norway is very very far away from the euro area being an optimal currency area, as it is described in macroeconomic theory.

Apart from these arguments, I think it is also worth highlighting that historical evidence shows that unilateral exchange rate pegs have been difficult to maintain, and hence mostly not a very successful tool for monetary policy. Norway, Finland and Sweden were all forced to abandon such pegs to the ECU in the early 1990s. Denmark is the only Nordic, perhaps even global, success story in this regard. For Norway to introduce a unilateral peg for the NOK to the euro would be a formidable task, and a bilateral peg under ERM II would, as you say, require EU membership first. And given the nature of Norway's economy, it would be a very poor currency match. A floating Norwegian krone is clearly preferable. Taking a long-term perspective, with Norway's aim to diversify its economy from oil and gas, a floating currency could ease this journey as well. With a fixed exchange rate or replacement of the NOK with the euro, competitiveness would have to be recalibrated with years or even decades of lower wages.

With the floating Norwegian krone, the central bank has the main responsibility for policymaking to help Norway's economy navigate macroeconomic cycles. Monetary policy, most importantly interest rates, is the key tool. With a pegged NOK, or even an adoption of the euro in Norway, there would no longer be any Norwegian monetary policy. This would leave fiscal policy as the main tool for managing the economy through macroeconomic swings. History has shown that it is a difficult tool to use. It tends to be "sticky", with political challenges in removing fiscal stimulus when the economy has improved. And timing is another problem. During the time between proposed fiscal support measures being proposed, being passed by parliament, and starting to take effect, the economy could have moved into a new phase where they are no longer needed, and could instead cause overheating. Also keep in mind that Norway is a wealthy country, not least owing to the big National Oil Fund. This could also affect how flexible a government could be in public spending, including how quickly and to what extent stimulus could be removed after an economic recovery.

JT: Would it be an option for Norway to peg the NOK to the USD?

KO: I would say not. The USD only represents 5-6% of Norway's foreign trade, so the direct exposure to the USD is quite limited. Europe is by far the biggest trading partner for Norway, representing 70-80%. In currency terms, the euro (including the pegged DKK) represents 43% of foreign trade, and the SEK 22%. The GBP is also quite significant. So, from an exchange rate risk point of view, pegging the NOK to the USD would not be particularly helpful – it is just too far from the actual FX flows. If for some reason you wanted to peg the NOK to another currency, the euro would from this perspective make more sense than the USD. But it would be far from ideal.

JT: As the world has globalised so much in the past 20-30 years, with complex supply chains and sourcing of materials, components, products and services in many different currencies, is a floating currency that could weaken during a shock as much help for a small, open economy as it has been historically?

HP: That is a good question, which may be difficult to answer very specifically. But let me put it this way: I think a fixed exchange rate can be a good thing for an advanced economy with high labour costs such as Denmark, because it forces companies and industries to be disciplined in staying competitive. They cannot count on the currency exchange rate to save them whenever there is trouble. Higher labour costs tend to stimulate innovation, because innovation is needed to drive productivity. And innovation is good for the economy. Currency depreciation – through devaluation of a fixed exchange rate or letting a floating currency weaken – is a short-term fix, and not a long-term solution for competitiveness.

AW: I agree with your point on high labour costs and productivity, Helge. And it is certainly true that our dependence on imports has increased. Many Swedish retailers are struggling with rising costs for their goods due to the weak SEK. For basic industries such as mining, steel, paper and forestry, the predominantly local-currency cost base and mostly international revenues create a massive FX tailwind. But for most industrial manufacturing, more assembly-type operations, international sourcing dilutes the boost from SEK weakness through more expensive imports.