The distressed countries in Europe’s southern periphery fear exiting or being expelledfrom the currency union, partly because they believe they would lose all the euro’sadvantages permanently. This fear could be laid to rest by making the eurozone an open currency union.

The core idea is to offer exiting countries the status of associated member, allowing them to adopt their own currency temporarily with the option to return to the euro at a later stage. An associated member would spare itself the trauma of a real depreciation inside the eurozone, which can only be achieved through a reduction of prices and wages that almost unavoidably entails economic contraction and mass unemployment.

Moreover, an associated member could receive financial help from the other eurozone countries. It could adjust its exchange rate quickly to restore competitiveness and, once it had fulfilled all reform commitments, could fully rejoin the eurozone.

A longstanding arrangement, the European Exchange Rate Mechanism II, could provide a basis for such a currency “association”. Conceived for EU member states that have not yet introduced the euro, the ERM II at present includes Denmark, Latvia and Lithuania. All countries that have adopted the euro since 2000 have done so on condition of spending a twoyear period within ERM II without stress, staying within a range of ±15 per cent with respect to a central rate against the euro. This mechanism could be expanded to allow it to harbour, after a transition period, countries leaving the eurozone, too.Any country that left the eurozone and introduced a national currency would immediately come under strong pressure to devalue. Once the exchange rate against the euro had settled down, joining the ERM II at a realistic central rate with more generous band margins could be considered. The ERM II could thus become a sort of “training space” for a subsequent return to the eurozone. As the depreciation and structural reforms of the countries affected began to make them more competitive, the band margins could be gradually tightened. Interventions by the European Central Bank and national counterparts (the ECB has such duties within the ERM II in any case) would remain manageable as the convergence with the now-smaller eurozone increased.

Historical examples show that such a scenario is possible. In October 1969, the Willy Brandt government in Germany decoupled the D-Mark from its link to the dollar in a matter of days, floating the exchange rate for a short period and later resetting it at a rate 9 per cent lower (ie an appreciated D-Mark). The British showed how not to do it in the early 1990s, when facing huge current account deficits they brought the pound into the parity grid at a rate that was much too high. After a short, intense wave of speculation, the pound had to withdraw from the programme. Argentina, which was forced to give up its 1:1 peg to the US dollar in 2002, experienced a stormy floating of the peso in the currency markets. In about 18 months, after heavy swings and depreciation, it found a new parity in the neighbourhood of three pesos to the dollar.

Thus in 2004 at the latest, it would have been possible for it to re-establish a fixed exchange rate, within a band, to the dollar. This proposal to open the currency union has a decisive advantage over either maintaining the status quo or allowing disorderly exits from the eurozone. It would give the countries affected a realistic, and therefore credible, hope of returning to the euro.Linking the new national currencies to the euro would support the operational efficiency of the single market. And countries would not be expelled from the club; their full membership would simply lie dormant for a couple of years. That would be a significant psychological factor making governments, and their electorates, more willing to persevere with painful economic reforms.