Euro riddle

Has monetary union helped structural reform in Europe? The 2007 Economic Survey of the Euro area attempts an answer. On the one hand, well-functioning markets and stronger supply incentives would offer scope to better exploit the benefits of the euro, by taking advantage of more price transparency and lower international transaction costs.

Given these benefits, the adoption of the single currency should have created strong incentives for euro area countries to undertake reforms, whatever the monetary policy position. On top of this, there is the TINA–There Is No Alternative–or “reform or die” argument: flexible product and labour markets are needed anyway if individual economies are to cope with shocks when fiscal policy is constrained.A key argument why reform may become more difficult in a monetary union is that the upfront costs may be larger. And if the benefits take a long time to appear under economic and monetary union (EMU), reforms may not be undertaken at all.A second sceptical argument is that monetary union removes the threat of an exchange-rate crisis between participating countries. Financial markets become less effective at punishing bad policies–although whether, say, devaluation punishes countries rather than helping them is far from evident.Theory aside, the concrete evidence shows euro area countries have in fact undertaken more comprehensive and far-reaching reforms than other OECD countries over the past decade. This may reflect a greater urgency, as well as preparing for monetary union, rather than the effects of EMU per se. However, the evidence also suggests that reform intensity has fallen since the advent of EMU in 1999, unlike elsewhere. Could it be that a lack of monetary autonomy tends to reduce the probability of structural reform? The euro area report finds that the evidence on this point is not strong.Nevertheless, the report draws some positive policy advice from all of this. First, euro area countries should undertake reforms well before reaching the point of crisis. Second, they should put their fiscal houses in order, as experience suggests that the benefits of structural reform seldom materialise until the budget situation has been brought under control. Third, financial market reforms that make it easier for people to borrow against their future incomes can bring forward the long-term benefits of change. Fourth, monetary policy should partially accommodate serious structural reforms in the euro area on strict conditions, such as maintaining low inflation and making prudent estimates of the impact of reforms on potential output. A commitment to a series of measures would also help. In fact, policy is usually more effective in packages than in piecemeal reforms, probably because packages put vested interests at loggerheads with each other: each group loses in some areas, but gains in others. Moreover, reforms to product markets, which may be easier politically, can pave the way for labour market reforms later on. References:©OECD Observer No. 260 March 2007

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