Euro: Less robust than you think

OECD Observer

Future of the euro 

Letter to the editor: Sir, Vincent Koen pronounces the euro to be a success, and argues that economic fundamentals suggest that the euro will appreciate against the US dollar over the longer term. I believe that such an assessment is premature: while the euro may appreciate in the medium term, its longer-term prospects look less robust.

It is necessary to be honest about what economic and monetary union is. It may sound and look like an economic accord, but in reality it is at first a political deal – from the premises of its inception to the discounting of the Maastricht criteria in 1998. EMU has merely glossed over the fault lines (of which I think five are significant) between the participating economies. While some of these – such as the pace of deregulation – are problems for the European Union in general, I would argue that the real risks to the euro arise from the differences among the countries. In the face of electoral pressures, national governments will seek accommodations. Instead of promoting greater intra-EU competitive pressures, the euro may foster more political interference with economic affairs, undermining the European Union’s long-term growth prospects.

The first of the fault lines is the asynchronous business cycles. The second fault line is the transmission of monetary policy, which acts on different lags and with varying impact on output on the national economies. Taken together, these two points suggest that while the ECB may be able to set an optimal monetary stance in the aggregate, monetary policy may be inappropriate for individual countries. Countries feeling excessively squeezed may demand a loosening of policy, leading to an inflationary bias for the euro area as a whole, and a risk that some of the more dynamic economies could over-heat. The third schism is the labour market: without a flexible exchange rate to mask trends in real wage differentials, but with continued labour market rigidities, unemployment may prove to be the mechanism that brings unit labour costs into greater alignment in the euro area. This could translate into legislation to protect jobs – jeopardising future employment growth.

The fourth potential problem is the pace of regulatory reform, much of which is determined in Brussels. While it is true that the EU is engaged in a process of liberalisation, so is the rest of the world. As the cliché goes, in the old economy, size was important, but in the new economy, speed counts. Those who reform more rapidly will be frustrated as the more lethargic countries hold up the pace of liberalisation at the EU level. Finally, there are longterm fiscal imbalances, notably the generational imbalances caused by an ageing population and expensive pension commitments, which could undermine the EU-wide commitment to fiscal prudence.

The dynamics of EMU will undoubtedly make the euro area a more homogeneous economic unit, and I do not think EMU will collapse. The risk to the euro is that competing national interests will render the euro area an unattractive business environment, and capital will flow out to seek better rates of return. The euro was designed to replace the Deutschemark, with the hope that it would replicate that currency’s postwar success. It may end up looking more like the British pound, with periods of strength unable to mask a longer term weakness.

MARK FEIGE, Washington DC

©OECD Observer No 221/222, Summer 2000 (Forum edition)

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