The Eurozone Sovereign Debt Crisis: Rethinking And Empirical Optimal Currency Area Theory

The research on euro seems to be divided by the euro zone’s sovereign debt crisis. Before the crisis, eurozone was the best practice of the Optimum Currency Area (OCA) theory in most researches, and the economic data of eurozone are often used to prove the promotion of single currency to the development of a currency area. However, after the breakout of the crisis, the previous optimism was almost immediately replaced by the opposite. The arguments that the experiment of euro has failed, that the eurozone is doomed to break up with the everlasting economic gaps between its member countries, and that the EU has declined as a power in the world, can be found everywhere.In fact, eurozone’s enlargement was not stopped by the sovereign debt crisis. Estonia has entered into eurozone within the crisis, Latvia did so after the crisis was eased, and Lithuania plans to enter in2015. So, the crisis has failed to cause apparent decline of eurozone’s attraction.So, the questions of how to understand objectively the impact of the sovereign debt crisis to eurozone, how to maintain smooth running of eurozone after the crisis, and what is the future of eurozone, will be focused in the research of this paper., which insist that we should consider the sovereign debt crisis while placing it into the process of European integration, and explore the essence of the crisis from the depth of the OCA theory.With the re-classifying of the OCA theory, and analyzing the relationship between euro and the OCA theory, the paper holds that if a single currency area wants to have its benefits exceed its costs, i.e., running smoothly, it needs to meet the following conditions, either its members have symmetric economics to reduce asymmetric shocks, or the absorbing mechanism is established to cope with asymmetric shocks. On this basis, the paper reviewed the process of the sovereign debt crisis, pointing out that the essence of the crisis is that the single currency area of eurozone consisting of sovereign countries failed to meet the above-mentioned conditions. In eurozone, the insufficient economic convergence leading to asymmetric shocks, together with the limited labor mobility and the lack of fiscal transfer resulting in the failure of macro adjustments, has given rise to the contagion and upgrading of the crisis. The following empirical test verified the judgment of insufficient economic convergence from the endogenous convergence effect. As its consequence, the paper then analyzed the impact of asymmetric shocks to eurozone, using VAR models to test the asymmetric shocks to eurozone brought about by the international financial crisis, and analyzing the mechanism that under the outside shocks, the asymmetric response of member countries caused tremendous cost increasing and finally had eurozone trapped into crisis. Finally, with analysis of fiscal integration and banking union, the paper holds that the policy adjustments in EU are helpful to the smooth running of eurozone. Driven by reforms and endogenous convergence effect, the eurozone will keep approaching the target of optimum currency area, and its running cost will get down gradually.