Necessity and dangers of the Euro - Le Blog Note d'Olivier KLEIN

The euro is necessary. This much is known. The single currency will enable loosening external constraints and giving more leeway to economic policy. The growth of one country of the European Union will no longer be stifled by the stagnation of another, the percentage of openness going from approximately 30% on average for each of the countries to 10% for the European Union as a whole. This will occur while procuring a more stable monetary environment for companies. Moreover, if we have the will, the euro will also allow for a foreign exchange policy and enable being better armed in international trade negotiations. Overall, on a European level, the single currency will effectively contribute to rediscovering, in the future, some of that capacity for international weight and the independence that is painfully lacking in each European country considered individually.

Article published in the newspaper Le Monde in 1997

The merits of the euro have been thoroughly analysed, although inadequately communicated. However, the introduction of the single currency could well be postponed, and even runs the risk of being aborted. And the major reason for this real threat is precisely the fact that the dangers resulting from the euro have been underestimated for too long. No doubt, the remedies to counter these dangers have not been viewed as adequately profitable in elections.

So, what are these dangers?

The exchange rate is a practical and necessary adjustment variable for a country. Certainly, in some conditions, it is one of the least painful adjustment variables. Does one country experience a so-called asymmetrical crisis that its main partners do not? A devaluation can allow it to re-establish itself with less of a setback, authorising it, by a more nature development of its exports and by acting as a monetary brake on imports, to more easily resume the path to growth. Does one country experience greater inflation than its neighbours? Does a lowering of its exchange rate allow it to maintain its outside competitiveness? There is no question here, however, of promoting devaluation as a cardinal point of any economic policy. But well-managed exchange rate adjustments have managed to prove their effectiveness, and the non-inflationary world in which we live today makes it more effective, as were the cases of Italy and Great Britain in 1992-1993.

By nature, the single currency eliminates any possibility of foreign exchange adjustment for a country taken individually, which risks making everything more rigid. Thus, the only way for a country going through an asymmetrical crisis to adjust itself is by lowering prices, increasing unemployment or emigration. These are difficult prognoses to accept!

This difficulty, however, can be remedied in three ways. We are in the heart of the current debate on the euro. The first solution consists of only allowing into the circle of countries with the same currency those that already have a very high level of economic integration, and are thus almost structurally in the same economic cycle, which significantly reduces the risk of uneven impact. This is why, before and after the advent of the single currency, the convergence criteria are important. This is the position of Germany in particular, which strongly holds to these criteria, even after changing over to the euro.

From this point of view, it develops a perfectly logical argument. But the passage is narrow since it only allows few countries (mainly those of the mark zone, including France) to join this circle. This is the origin of the open question about the southern countries, particularly Italy in recent months.

In addition, the Maastricht criteria, as defined for some of them, have not been adapted to cyclical changes. If we wanted to adhere to them at any cost, they would cause the slowdown of the much anticipated boost in growth. Consequently, Germany has thus opted for the following alternative: rigidly doubling down, in accounting terms, on the criteria and taking major risks for growth, or making it a “policy” reading, but no longer having a presentable argument to put before southern Europe to persuade it to wait. This is part of the current pressure in Germany to push back the date of changing over to the euro.

The two other solutions do not eliminate the need for a convergence, a priori and a posteriori, to reduce the risks of uneven impacts, even if it means re-examining the criteria. However they are not happy with that. The second solution is thus based on a stronger idea of what the countries having adopted the euro can share. It consists of coordinating economic policies through appropriate bodies such as a “Council for stability and growth”.

On the one hand, this coordination would enable implementing a stimulus policy in an articulated and complementary manner, and a policy for austerity, according to the cyclical phases, on the other hand, thus playing the “win-win” game and not the game of “every man for himself” which most often makes all players lose.

The third solution is no doubt the best economically, the most logical and the only one to complete the construction of Europe, both monetarily and politically. Let us remember that a centralised monetary power has always been accompanied by a similar movement on a political level. Only greater political integration, leading to a greater degree of federalism, can structurally reduce the dangers of a lack of flexibility engendered by the common currency. Then only, as in the United States of America, for example, an economic crisis in one state can be absorbed without the play of relative price movements and employment adjustments alone. A community-level decision-making centre equipped with some tools and expertise, acting only in the principle of subsidiarity, is necessary to institutionalise the Member States’ obligation to cooperate. Federalism allows the coexistence of decentralised state powers and a regulating and coordinating power in the centre.

A federal budget worthy of this name, that does not add to national budgets, would in fact allow transfers of revenues to the affected State and would thus facilitate the necessary adjustments, making them less dramatic and more tolerable. This would not at all exclude the community rules which aim to make each country adhere to minimum “economic wisdom” criteria. This higher degree of federalism should also allow instituting European tax and social minimums. Let us not be fooled; this risk of a race to the bottom – fiscally or socially, so to speak – is one of the major causes that could hinder the construction of Europe.

As far as the euro is concerned, to continue to think like novices that an economically unified Europe will automatically lead to a politically unified Europe is perhaps already a historical error that risks bringing the construction of Europe to a halt.