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Lithuania: Why join the euro?

Jasper SkyJune 20, 2014

Lithuania will become the eurozone's 19th member country on January 1, 2015. The move was approved by the bloc's finance ministers and is geared to deepening the country's integration within Europe.

Lithuania plans to join the eurozone
Image: picture-alliance/dpa

Estonia and Latvia have already adopted the euro currency - Estonia in 2011 and Latvia in 2014. Now Lithuania, as the last of the three Baltic countries, is set to follow suit. The eurozone's finance ministers gave their approval at a meeting in Luxembourg on Thursday. The European Commission and the European Central Bank confirmed earlier this month that Lithuania has met the technical criteria for eurozone membership.

EU leaders and the European Parliament must still give their nods, and are expected to do so soon, closing the lengthy approvals process.

Given the turmoil in eurozone countries' economies during the past several years, Vilnius' apparent eagerness to adopt the euro may seem surprising. Membership in the euro effectively means having a fixed exchange rate with the other eurozone countries, including powerful, dynamic economies like Germany's.

The terms of the European Union's Maastricht Treaty of 1992 require all EU countries to join the euro currency eventually, with the exception of Denmark and the United Kingdom, which negotiated special exemptions. But some countries, like Poland and Sweden, have deliberately avoided fulfilling the technical requirements of eurozone membership (including specific targets for low deficit spending and low inflation) in order to retain the advantages of keeping their own national currency.

A national currency is a powerful tool for economic flexibility

It can be useful for a country to have its own currency. It makes it possible for a country to devalue its currency when its economy gets into trouble. A weaker currency encourages exports. It also induces domestic consumers to switch away from imported products and buy comparable domestic products instead. Both of these factors stimulate domestic job creation.

But if a country like Lithuania, Portugal or Spain doesn't have its own currency, or has a fixed exchange rate with a powerful currency like the dollar or the euro, then devaluation isn't an option. Under those circumstances, if the country's economy runs into trouble -- either because of weaker exports or weaker domestic demand - then the economic policy options for returning to economic growth are fewer. Exports must then be stimulated by substantially increasing productivity per worker-hour, which is difficult, or by "internal devaluation" - i.e. slashing wages, which harms domestic aggregate demand and can drive the economy into a deep recession. That's what happened in Spain and Portugal in the post-2008 crisis years.

Vilnius, Lithuania
Vilnius, the capital of LithuaniaImage: imago stock&people

Lithuania is trading exchange rate flexibility for security and investibility

In Lithuania's case, the government decided that on balance, there was a strong case for dropping its existing currency, the litas, in favor of the euro, despite the reduced economic policy flexibility that it will mean. In an interview with the Financial Times (29.12.2013), Lithuanian Finance Minister Rimantas Sadzius cited several arguments in favor of joining the euro.

First, Lithuania, like the other Baltic states, has been using every opportunity available to deepen institutional ties with the European Union in order to deter Russia from any temptation to attempt to regain the kind of control it had over the Baltic nations in the Soviet era. Second, the litas has already been pegged to the euro for several years, so the country isn't really giving up much policy flexibility. Third, the other Baltic countries already use the euro, and joining them will encourage regional economic integration.

Finally, by staying out of the club in the past, Lithuania has been a comparatively less attractive destination for inward investment from the rest of Europe, by generating exchange rate uncertainty. Lithuania needs foreign investment because as a small and open economy, it doesn't have enough investment capital of its own.

Taking all that together, the costs to Lithuania of joining the euro - above all, the need for "internal devaluation" when the economy runs into headwinds - are outweighed by the benefits.

The euro: Not everyone's cup of tea

For several other countries, that isn't the case, at least for now. In addition to the UK and Denmark, which are not obliged to join and have no plans to do so, Sweden and Poland clearly prefer staying outside; some are ambivalent (Hungary, Czech Republic); and some (Romania, Bulgaria, and Croatia) don't yet meet the eurozone's convergence criteria.

Lithuania has cast its lot with the euro, but the other European countries still outside the eurozone are in no hurry to follow suit. Experts say it could be ten years before another country joins the eurozone.