Marty Feldstein, back before the start of the euro, was greatly worried that a single currency would result in too much business-cycle volatility across Europe: countries would not be able to use either fiscal or monetary policies to stabilize their domestic economies because both would be fit to a common European pattern. In Business Week this week, some evidence that his fears were well-founded.
Of course, that doesn't tell us what to do now...
Posted by DeLong at January 24, 2003 07:59 PM | TrackbackBW Online | January 24, 2003 | The Euro: One Size Fits None: Too much political capital is at stake -- especially in Germany and France, the euro zone's key economies -- for the euro ever to crumble. But as Germany's economy slumps into its second year of recession, the difficulties of designing a single monetary policy for 12 different countries are increasingly evident.
That's worrying many of the senior businessfolk gathered in Davos, Switzerland, for this year's World Economic Forum. "The euro zone's monetary policy isn't a case of one size fitting all but of one size fitting none," says the chief financial officer of one Spanish company. "The result is that Germany is having to cope with higher interest rates than it needs, and its economy is slowing as a result. And that's affecting everyone across Europe."
SPENDING LIMITS. The problem is the Maastricht Treaty mandates that the European Central Bank maintain price stability across the entire euro zone. It can't take conditions only in Germany into account when setting rates, even though Germany is the Continent's largest economy and is a drag on growth in other countries. The ECB's key interest rate stands at 2.75%, whereas economists say Germany really needs a rate as low as 1% to stimulate demand, investment, and growth.
Fiscal policymakers in Berlin are powerless to kick-start the sputtering economy because the Stability & Growth Pact puts tight limits on state spending. In particular, they may not run a budget deficit above 3% of gross domestic product. Germany's euro-zone partners have just censured it because it breached the 3% limit last year and will probably do so again this year.
Some eminent economists, such as Robert A. Mundell, professor of economics at the School of International & Public Affairs at Columbia University, argue that the Stability Pact should be scrapped and that the ECB should be given a broader mandate. Yet many European business executives take the opposite line. Gerard J. Kleisterlee, president and chief executive officer of Dutch manufacturing giant Royal Philips Electronics, says the single currency needs to be underpinned with sound state finances. Ironically, German government officials agree. Caio Koch-Weser, Germany's Secretary of State of Finance, says it would be a mistake to abolish the pact.
what exactly would be the problem with scrapping the Euro? Besides loss of face, that is.
If the Euro zone is hopelessly large, then how does the US economy function with a single currency? Doesn't the Fed have the power to set different interest rates in different regions? I understand why a large difference in the central bank rate from one area to another is damaging, but why can't Germany have a 1% rate and the rest of Europe 2% if the circumstances call for it? Banks aren't that mobile.
Lastly, the US manages to function without imposing controls on public spending on local governments. Why does California's huge deficit cause little or no concerns about monetary stability, while a 5% German deficit does?
Posted by: Scott Martens on January 25, 2003 02:53 AMfor R. vesseau,
If the EU scrapped the euro, it would have a cost similar to the one we had to implement it. And we would lose a lot of liquidity, since businesses would need to keep a diversified reserve of money for each state with which they work. While I've no proof of it, it looks to me that part of the flux of eurocapital that was invested in the USA came from these no longer needed reserves. Now, for the USA the division in various currencies of the EU market was beneficious, since being a major trade-partner its currency was favored as reserve beyond the direct trade proportion. So a Finnish corporation would trade in dollars with a German one, now they can do it with euros, and avoid change risk.
Now I am no economist, so I may have misunderstood the situation.
DSW
Posted by: Antoni Jaume on January 25, 2003 03:25 AMTo S. Martens,
banks aren't mobile, but capital is. Without change risk where would you put your money, in a 1% interest-bearing account, or a 2% one? Now in fact I could borrow 1 million € at 1%, put it in a 2% account and obtain a risk-free work-free return on 10000 € a year. Very good for productve economy, isn't it?
DSW
Posted by: Antoni Jaume on January 25, 2003 03:37 AMI've never understood whether states' budget deficits are included in the US budget defict total when international comparisons are made.
For example I think California's defict is $21 to $34bn (depending on who's measuring it) and that is said to be half the total states' deficits, so let's say $50bn in total.
Is this is added on to the Federal defict of $150bn or $250bn or $500bn (sorry I haven't check today's figure...) to get a total US defict?
Posted by: Matthew on January 25, 2003 04:23 AMScott Martens: The US does a bit better than the EU because almost everyone in the US speaks English. This means it's vastly easier for someone to move from Omaha to San Jose to get a new job, than it is for someone to move from Budapest to Dublin. This makes up for differing economic performance because people can easily move from poorly-performing regions to hot regions. Google for "asymmetric shocks" if you want to get into the guts of this. Here's a paper from the Atlanta Federal Reserve looking at how our currency union affects US states.
To S. Martens,
I had forgotten that USA federal budget is greater than EU budget. And since it gets its monies from individual through federal taxes, it has a lot more room to choose what to do with them.
DSW
Posted by: Antoni Jaume on January 25, 2003 04:29 AMDon't scrap the pact! It would only mean less structural reforms which are badly needed. Maybe it's a painful way of adjustment, but it seems there is finally a little incentive to actually get going.
As for the Euro itself, I generally agree with
Buiter, Willem H. (1999), "Alice in Euroland," CEPR Policy Paper No. 1
- "great idea, (partly) bad execution".
Posted by: Tobias on January 25, 2003 06:39 AMOne huge problem is that the Euro's crafters quite deliberately burned their bridges, allowing no roadmap for returning to legacy currencies.
There is a possibility that a Euro-currency structural failure would be followed not by going back to marks/lira/fancs, but by dollarization due to lack of a liquid trusted alternative.
Posted by: Bucky Dent on January 25, 2003 07:35 AM“Scott Martens: The US does a bit better than the EU because almost everyone in the US speaks English.”
I hope that he goofy multiculturalist read your comments. A single language is indeed a blessing (I hate to refer to the Old Testament like some fundamentalist Christian, but God cursed the population by smashing the tower of Babel) Why couldn’t it be the German of my ancestors? Or Spanish, Eskimo, or Navaho? Hey, life isn’t always fair. The English speaking folks won that fight, and now its best for the rest of us to get over it. Neel Krishnaswami is from a part of the world that benefited greatly from the domination of the English language. More people in India speak English than in all of the United States.
I am not a professional economist. However, I fail to see how a single currency is possible unless all of the participating states have agreed on implementing the same essential economic policies.
Posted by: David Thomson on January 25, 2003 07:54 AM>>what to do now...
I suppose the best we can do is watch and wait, and since this show is likely to run and run, follow a piece of advice from Antoni Jaume's native Catalan and 'llogar-hi cadires' (in simple English rent out seats to those who want to watch - the Catalans always did have good business acumen).
On the one hand the inflation riddled southern fringe (Spain, Greece, Portugal) may find themselves launched into an Argentina-style rapid exit mode as rapidly rising costs make it increasingly difficult to create new jobs and recession sets in harder and harder, or on the other the German voters who are being asked time and again to foot the bill may themsleves get so fed up that they decide they want the mark back and ask to leave.
Either way things are still going to have to get a lot worse before anyone bites the bullet on decisions. However recent events on the Iraq front may ironically have given matters a hefty push. I don't know if anyone else is following this, but I can't help noticing that each time an Iraq hawk makes a strong speech the dollar drifts down a few points. Meanwhile the US treasury stays strangely silent. Reading Ben Bernanke carefully, it's clear that a weak dollar is a good hedge against perceived deflation dangers, so letting it drop without openly changing policy seems like a smart move. A kind of knock-on Iraq effect. Meantime up and up goes the Euro. Since one common candidate on everyone's shortlist of potential 'Japans' is in fact Germany, this could be just the shock they need (this and the firm fiscal tightening coming from the stability pact) to get them well and truly going. In which case, ZIRP will be the order of the day, and then.......
It is interesting to note that Euro membership is not synonymous with EU membership, as with the 10 new entrants a majority of EU members (13-12) will not be in the Euro. The following link from Morgan Stanley's Global Forum might be of interest since it shows that the 4 key new Eastern entrants are all quietly dropping their currencies with the dollar to maintain competitiveness:
http://www.morganstanley.com/GEFdata/digests/latest-digest.html#anchor5
As a personal reflection, I'd like to acknowledge an article in Foreign Affairs 1996 by the late Rudi Dornbusch as the initial source of my own awakening to the impending problems of the then prospective European single currency. Subsequent misgivings among some academic economists in Europe were not uncommon, as this shows: http://www.internetional.se/9802brdpr.htm
But much of the early popular and political debates in Europe were conducted very largely in the political dimension. Advocates saw the single currency as an essential and urgent step towards ever closer political integration in Europe through even to a Federal Europe. Sceptical economists tended to be dismissed as lacking vision or even as "blasphemers" and "heretics" - and I joke not.
There is an economic case for the Euro. The fundamental economic issue is whether the benefits are worth the downside risks to the stability of national economies from loss of monetary autonomy by complying with the one-size-fits-all interest rate necessarily prevailing thoughout the Eurozone.
From a British perspective, it is not accidental that the large multinational manufacturing companies based in Britain and trading into the Eurozone tend to be the most enthusiastic on business grounds for joining. For them, there are prospective benefits through cutting out currency-exchange transactions costs and from avoiding the uncertainties of exchange rate fluctuations on intra-Eurozone trade - although not, of course, on trade with the rest of the world since the exchange rate of the Euro will continue to fluctuate against other currencies. For buyers, whether as consumers or businesses, there is the greater ease of making cross-border price comparisons in the Eurozone which will intensify producer competition.
If there were significant economic disadvantages from a large, single currency area, the monetary union of the American economy would not be the success it is. The factor to notice is that Canadians, with only half Britain's population and a smaller economy than Britain's, show no inclination to give up the Canadian Dollar and adopt the US Dollar instead, even though both Canada and the US, together with Mexico, belong to NAFTA. The possibility of a free trade area for South America has been mooted, as has the possibility of a free trade area for all the Americas. However, no one is proposing a common currency for north and south America and for very good reason. Argentina nailed the exchange rate of its currency to the US Dollar in the early 1990s as a means of curbing inflation there - a decade later that has become one of the main factors contributing to Argentina's present economic disaster.
A useful reference on the events leading up to the launch of the single currency by Michael Klein, a FED economist, is at: http://occawlonline.pearsoned.com/bookbind/pubbooks/mishkin-eakins_awl/medialib/readings/reading16.pdf
A recent rumbustious critical assessment of the failings of the Euro project since its launch is at: http://www.no-euro.com/factsfigures/pdf/notworking.pdf
Posted by: Bob Briant on January 25, 2003 08:09 AMMilton Friedman also warned about the dangers with the euro, for instance:
http://www.stanford.edu/dept/news/report/news/october28/friedman1028.html
>> "I've been very negative about the Euro because I feel the conditions are not present. In the United States, we have people, all of whom speak some approximation of the same language" the audience interrupted with knowing laughter "free to move about, and lots of real movement, and we have a large central government," he said. That means that when an oil crisis hits Texas, Texans can move to California, or Washington, D.C., politicians can take action to relieve Texans' pain. Europe, he said, has large local governments, a small central government and rigid price regulations. But, he conceded, they may be "lucky enough to have no shocks that affect one country" different from the others, in which case they may be able to loosen up the current regulatory schemes that inhibit economic growth. "I hope it does succeed, but it will be fascinating to watch," he said.
Posted by: Patrick R. Sullivan on January 25, 2003 09:19 AM>>lucky enough to have no shocks that affect one country different from the others
Unfortunately this is just what hasn't happened. The Euro countries have been unlucky enough to be hit - in unequal measure - by the bubble backdrop: possibly one of the biggest shocks to the financial system since the 1930's, and in the first year of the currency's existence to boot. At the same time just around the corner a downside demographic shock is looming which is every bit as big as the industrial revolution upside one which ushered in the transition from Malthusian to growth economies. And again this transition will hit different countries differently depending on fertility, immigration etc. As Steven Roach suggested yesterday, the initial conditions here are all important, and unfortunately the Euro initiative seems to have come as the wave of pan-European sentiment is declining, not rising. In 1992 (and without the British and the Italians) it might have been a different story, at least in the short term.
Posted by: Edward Hugh on January 25, 2003 09:50 AMHere's another interview with Friedman, in which he went as far as predicting the euro might not get off the ground:
http://www-hoover.stanford.edu/publications/digest/982/friedman3.html
BRIMELOW But the will of Europe's political elite to do this is phenomenal.
FRIEDMAN Phenomenal. The people are opposed to it. And who is being stupid in all of this, in my opinion, is the business community in Europe. It's not going to benefit from the euro. It's going to be harmed by it.
BRIMELOW Why?
FRIEDMAN Because the euro will lead to a less prosperous Europe. For example, Spain is hit by something. It can't adjust by having its exchange rate fall; it's going to adjust by rules, by regulations, by more control.
BRIMELOW Will the euro be an inflationary or deflationary factor in the world economy?
FRIEDMAN Neither inflationary nor deflationary--if there are floating exchange rates. And most exchange rates float.
But who knows what's going to happen if they go to the euro? There could be a real donnybrook in Europe.
--------------------------->>
Actually there is often speculation in Canada about giving up the Canadian Dollar and using the US one. I happen to think it's a bad idea - but it has been floated a number of times, quite recently, by the federal government, no less.
The US has paid a price for a single currency. Perhaps that price is worth it and perhaps the price being paid for the Euro is worth it. But I wouldn't have done the Euro, that's for sure. I think the point that it was as much, or more, a political decision than an economic one is a good one.
Posted by: Ian Welsh on January 25, 2003 11:06 AMWhat price has the U.S. paid for having a single currency? Due to common language and relatively small cultural differences between regions, we benefit from mobility of capital and labor and the single currency's a huge plus.
Anyway, these EURO issues are relatively mild compared to what's coming. At the moment in Germany, both monetary policy (restrictive) and fiscal policy (raising taxes) are going to further slow an economy that's already faltering in recession. But the ECB, which isn't based in Brussels, is dominated by anti-inflation Germans, so they're not so worried, yet. And the demographic time bomb + exorbitant retirement and healthcare commitments keep marching forward. UGH.
At the moment, because EURO rates are high relative to the rest of the world and because monetary policy is too tight even as the major German and French economies slow, EU BONDS are very attractive. So money is rushing in from around the globe to buy EU bonds. That's why the EURO is going up, in addition to the dollar falling on concerns the Iraq war will go badly.
Posted by: Anarchus on January 25, 2003 11:35 AMMilton Friedman was a great economist but on the euro his views have to be taken with a pinch of salt. He said it would never happen only a year before it did happen. Not the best authority then.
Posted by: Matthew on January 25, 2003 12:50 PMMilton Friedman was a great economist but on the euro his views have to be taken with a pinch of salt. He said it would never happen only a year before it did happen. Not the best authority then.
Posted by: Matthew on January 25, 2003 12:51 PM>Anyway, these EURO issues are relatively mild compared to what's coming. At the moment in Germany, both monetary policy (restrictive) and fiscal policy (raising taxes) are going to further slow an economy that's already faltering in recession.
There are now reports of complaints about the strength of the Euro - see http://news.bbc.co.uk/1/hi/business/2683197.stm
"Milton Friedman was a great economist but on the euro his views have to be taken with a pinch of salt. He said it would never happen only a year before it did happen. Not the best authority then."
Huh? The fact that Milton Friedman failed to predict that the euro would become reality does not reflect on his overall views on the matter. If nothing else, one could argue that Friedman thought they wouldn't do anything that stupid!
Posted by: David Thomson on January 25, 2003 01:49 PMMilton Friedman was far from being a lone critical voice warning that monetary union in prevailing conditions in Europe was, at least, premature.
A Brit, Bernard Connolly, who was at one time head of the EU Commission's unit on monetary policy, was sacked from his job in 1995 for making critical comments - he gives his account of what happened in: The Rotten Heart of Europe (1996; ISBN 057117521X).
The late Rudi Dornbusch as well as Marty Feldstein both made sceptical assessments in separate articles in Foreign Affairs during 1996 and 1997.
As cited in a post above, more than 150 academic economists in Germany in 1998 with misgivings about the Euro on the eve of its launch had recourse to the courts to block Germany's participation in the Euro on constitutional grounds - see one accessible Financial Times report at: http://www.internetional.se/9802brdpr.htm
Critical discussion of the European Monetary Union in mainstream macro texts by Dornbusch, Fischer and Startz (8th edition, 2001) and also in Blanchard's Macroeconomics (3rd edition, 2003) should give cause for reflection but the problem was and is that critics tend to get dismissed as lacking the necessary vision or even as subversive heretics. From personal experience of engaging in online debate about the Euro for more than six years, it is extremely difficult to maintain discussion about the substantive economic issues. All too often, critics of the Euro were and are dismissed with sneers and smears, not with convincing analysis. Some of us believe at least part of the present economic problems of the Eurozone are a direct consequence of blocking off rational discussion in order to drive through what was and is regarded as a political imperative.
As reference to the statistical annex of the current issue of The Economist shows, the UK's unemployment rate is 5.2%, compared with 8.4% in the Eurozone and the UK's GDP growth rate to 2002Q3 was 1.8%, compared with 0.8% in the Eurozone.
As for inflation, according to the UK's Office of National Statistics: "The 12-month change in the HICP, the internationally comparable measure of inflation, was 1.7 per cent in December, up from 1.6 per cent in November. The EU average inflation rate for November was 2.2 per cent. The UK HICP inflation rate has been among the lowest in the EU since the start of 2000." - from: http://www.statistics.gov.uk/cci/nugget.asp?id=19
In all, that doesn't look an attractive combination for the UK to join the Eurozone.
>> Without change risk where would you put your money, in a 1% interest-bearing account, or a 2% one? Now in fact I could borrow 1 million € at 1%, put it in a 2% account and obtain a risk-free work-free return on 10000 € a year. Very good for productve economy, isn't it?
If differential interst rates within a currency area lead automatically to massive exploitation by lenders, how does the US manage when the Fed sets slightly different interest rates within the US. I realise the Fed doesn't let regional rates vary terribly much, but I remember quite explicitly Alan Greenspan announcing at one point interest rates from the Federal Reserve in St. Louis that were 0.25% lower than the overall federal rate. IIRC, his reason was a depressed housing market in the lower plains.
0.25% isn't much, but if it is really free money, why doesn't this happen in the US?
>>The US does a bit better than the EU because almost everyone in the US speaks English. This means it's vastly easier for someone to move from Omaha to San Jose to get a new job, than it is for someone to move from Budapest to Dublin.
and
>>[quoting Friedman] "I've been very negative about the Euro because I feel the conditions are not present. In the United States, we have people, all of whom speak some approximation of the same language" the audience interrupted with knowing laughter "free to move about, and lots of real movement..."
I don't have statistics on labour mobility in the US, but my experience is almost exactly the opposite. Americans rarely move in response to economic changes, and when they do it is years and years - often a decade or more - later. The US still has manufacturing towns full of unemployment when the factories have been closed in some cases for 20 years. Furthermore, when they do move in search of work, it is rarely beyond the nearest large centre. At any rate, by the time the labour force has moved in response to new demands, economic crises are generally over.
Moving in Europe seems to be just as rare, but I know a half-dozen people who commute more than two hours in each direction - across a national border - for their jobs.
Nor does the existence of asymetric shocks strike me as a well-founded argument against the euro. The US experiences regionally asymetric shocks all the time. If labour doesn't move very much, but capital does how is the US experience different from Europe's?
>>I had forgotten that USA federal budget is greater than EU budget. And since it gets its monies from individual through federal taxes, it has a lot more room to choose what to do with them.
and
>>[quoting Friedman some more] "...and we have a large central government," he said. That means that when an oil crisis hits Texas, Texans can move to California, or Washington, D.C., politicians can take action to relieve Texans' pain."
Now this line of thinking makes some sense to me, except that it isn't flushed out. How does central taxation authority mitigate the effects of a single currency? Through asymetric redistribution of income? If so, does this mean the EU would work better if Brussels raised taxes and passed them around to national governments? Or if it took military spending up on a Union-wide basis?
Besides, listen to Friedman. He is clearly a some elite liberal socialist with his advocacy of a large central government and a uniform culture. :^P
>> However, I fail to see how a single currency is possible unless all of the participating states have agreed on implementing the same essential economic policies.
When exactly did this happen in the United States? What is essentially the same about Texan and Californian economic policy? They don't even have similar major industries.
And tell me David, what is the opposite of a goofy multiculturalist? A stuffy ethnocentrist?
>> But the ECB, which isn't based in Brussels, is dominated by anti-inflation Germans, so they're not so worried, yet. [...] So money is rushing in from around the globe to buy EU bonds. That's why the EURO is going up, in addition to the dollar falling on concerns the Iraq war will go badly.
Now Anarchus, in light of this statement, do you think the ECB should have had Jean-Claude Trichet as its president instead of Wim Duisenberg? Would Europe be better off with a loose monetary policy in the hands of a full-employment oriented French mandarin? Also, does the increase in foreign investment in Europe, due to the high interest rate of eurobonds and the poor state of the American economy mitigate the effect of Europe's demographic situation and high social benefits? Does the influx of money into European markets give the ECB more or less flexibility to set lower interest rates? And finally, considering that the EU is far more dependent on middle eastern oil than the US, why has the possibility of war in Iraq depressed the value of the dollar compared to the euro instead of the other way around?
Note that these are trick questions and I will hold your answers against you.
Posted by: Scott Martens on January 25, 2003 03:36 PMCurrency values act either to increase buying power or to subsidize exports, correct? (With some caveats). So, if you're in a part of the country (the US) which is in recession while other parts are booming (and this happens all the time) both of you aren't getting the currency support you need. Are you? There are always transaction costs to moving people and production, it's not something that happens automatically.
That's the cost of having a single currency over multiple economic areas.
Posted by: Ian Welsh on January 25, 2003 05:59 PM>I don't have statistics on labour mobility in the US, but my experience is almost exactly the opposite. Americans rarely move in response to economic changes, and when they do it is years and years - often a decade or more - later. ... Moving in Europe seems to be just as rare, but I know a half-dozen people who commute more than two hours in each direction - across a national border - for their jobs.
"Direct evidence on the extent of interregional labor mobility is hard to find. The one systematic comparison of which I am aware concluded that mobility within the United States was two to three times as high as mobility within European states. . .
"The problem with this evidence is that relatively low levels of labor mobility may reflect a lesser incentive to move rather than a lower level of intrinsic mobility. . .To address this possibility, a number of authors have considered the behaviour of variables that contain information about the incentive for migration. Boltho, for example, examined evidence on regional income differentials in the United States, in the [European] Community, and within various European countries. For 1983, the coefficient of variation of per capita incomes was 0.25 for 12 EC members, but only 0.10 for 9 US census regions. This would appear at first glance to be strong evidence of the effects of greater factor mobility within the United States. When the same statistic is calculated for only 9 EC members (excluding Greece, Portugal and Spain), however, it falls to 0.16. Still, a noticeable differential remains.. .
"I examined the speed with which unemployment rates in various EC countries, when perturbed, converged to its long-run equilibrium relationship to EC-wide unemployment, and compared that with the speed at which regional unemployment rates in the United States converged to the national average....The results suggest that regional unemployment rates adjust to one another about 20 times more rapidly in the United States than national unemployment adjust to one another in the [European]Community."
From: Barry Eichengreen: European Monetary Unification; MIT Press (1998), p. 58-61
Posted by: Bob Briant on January 25, 2003 06:31 PMEr...David Thompson once again misses the point. If MF predicted, using all his knowledge, that the euro would never exist, then now it does, one has to wonder what expertise he can offer us.
That is obvious.
Posted by: Matthew on January 25, 2003 06:46 PMAs Barry Eichengreen's data proves, this comment is wildly off mark: "I don't have statistics on labour mobility in the US, but my experience is almost exactly the opposite. Americans rarely move in response to economic changes, and when they do it is years and years - often a decade or more - later."
I was in Houston in 1978-1981, a time when the oil industry was booming and the rust belt in the mid-west was collapsing. The flow of U-Haul trailers into Houston was so overwhelming that the company had to ship them back into the Midwest (especially the Detroit area) by railroad. The U.S. workforce is mobile, very mobile.
These questions are silly: "Now Anarchus, in light of this statement, do you think the ECB should have had Jean-Claude Trichet as its president instead of Wim Duisenberg? Would Europe be better off with a loose monetary policy in the hands of a full-employment oriented French mandarin? Also, does the increase in foreign investment in Europe, due to the high interest rate of eurobonds and the poor state of the American economy mitigate the effect of Europe's demographic situation and high social benefits? Does the influx of money into European markets give the ECB more or less flexibility to set lower interest rates? And finally, considering that the EU is far more dependent on middle eastern oil than the US, why has the possibility of war in Iraq depressed the value of the dollar compared to the euro instead of the other way around?"
I don't have a position on who should be running the ECB. It is widely understood that the German central bank has a demonstrated bias towards keeping monetary policy too tight. I don't know or care who would be better at the ECB - probably someone such as Merlin or Harry Houdini would be good, because given the disparate economies in EU-land and the lack of labor and capital mobility, running the right monetary policy requires the skills of a magician rather than an economist! I could be wrong about this, but I suspect that Jean-Claude Trichet may get the jail cell next to Jean-Marie Messier. Not a good time for the Jean's, I suppose.
As for the stuff about capital flows into EU-bonds and other mitigating factors, there's no answer for a question that makes no sense. The American economy has been outperforming Germany and France and Italy for some time and that gap will continue. The demographics and large social benefits disaster won't strike Europe for another 5-10 years, BUT the high costs of labor have saddled the continent with a much, much higher structural rate of unemployment than in the US. As importantly, so what if there's a little stimulus from capital inflows bringing down intermediate-to-long term interest rates for Germany and France? It's only a little, and it's offset to a large extent by the loss of export competitiveness due to the run-up in the EU exchange rate. And the German tax hike in the face of recession is a huge negative, as is the loss of confidence in the German government overall.
Last, the sharp decline in the exchange rate of the dollar in advance of war in Iraq is a surprise for many observers, including myself. Part of the EU strength is due to interest rate differentials PLUS the weakening economic conditions in Europe. EU bonds are very attractive in those circumstances, but German and French stocks are not. Beyond that, there are clearly other factors at work pushing the dollar down and the EU up - mostly relating to war jitters. Big wars have always been hugely expensive, and if this one turns out that way then conventional wisdom would expect that U.S. deficits could balloon, inflation could run amok and the dollar would depreciate rapidly.
That's the negative case, which I don't ascribe to, but evidently conventional wisdom does. Time will tell.
Matthew is flatly wrong in this:
>> Milton Friedman was a great economist but on the euro his views have to be taken with a pinch of salt. He said it would never happen only a year before it did happen. Not the best authority then.
He only said it *might not* come about. He was thinking that Europe might come to its senses, before actually going forward. His predictions of a "donnybrook" look pretty good.
Posted by: Patrick R. Sullivan on January 26, 2003 12:37 PMPatrick: He only said it *might not* come about. He was thinking that Europe might come to its senses, before actually going forward. His predictions of a "donnybrook" look pretty good.
You may need to understand that demonising Milton Friedman is a popular hobby sport with part of the political left in Britain.
If personal experience is any guide, many of the hobbyists have a problem or two reading his academic books and papers and the target name is often truncated to Friedman, as though that mattered - not too long back, in a message board exchange elswhere, I needed to post a request asking whether the instigator there was referring to David, Lee, Milton or to Thomas Friedman. Of course, that was just nit picking. Never mind the argument, feel the bile. The fact that dozens and dozens of economists have criticised the Euro project is mere detail and their reasons a tiresome distraction.
Posted by: Bob Briant on January 26, 2003 03:48 PMI was talking to a europhile friend of mind about the problems with a Europe-wide currency (unless people will move in response to geographical boom/bust cycles, higher unemployment on average, blah blah blah.) His response was that the EU has made it quite a bit easier to move between countries, and it's becoming increasingly common.
Anecdotal food for thought, I guess.
Don't scrap the pact! It would only mean less structural reforms which are badly needed. Maybe it's a painful way of adjustment, but it seems there is finally a little incentive to actually get going.
....and here we find the real reason lots of people support the euro - it's a trap! :D
Posted by: Jason McCullough on January 26, 2003 04:26 PM>Anecdotal food for thought, I guess.
About a year back or so, in a BBCTV interview, Marc Roche, the London correspondent of Le Monde, claimed there were 250,000 French citizens living in London. I think, he meant in and around London but that is a huge number in context anyway and probably reflects the miserable job prospects in France, especially for the under 25s and despite the Socialist government there until the elections last year. London is so hugely cosmopolitan that foreigners are just part of the natural landscape. Even in 1847, Disraeli, who became one of our prime ministers, could credibly write that: London is the modern Babylon - and btw his grandfather was an immigrant.
What is significant now is that the London region has the highest unemployment rate among UK standard regions apart from North-East England, which is joint top. But then the British government is taking up to £20 billion a year in taxes net of spending out of London to fund spending elsewhere. Even so, London's unemployment rate is lower than the unemployment rate in France of 9%, up from 8.8% a year ago. No suprise then that in poll after poll a steady majority of Brits reports that they don't want to join the Eurozone. With all the talk of policy harmonisation in the EU and an unemployment rate of 8% in the Eurozone, who can blame them?
Posted by: Bob Briant on January 26, 2003 05:58 PMThe widespread criticism of the euro among economists hardly seems surprising, if one accepts that the principal driving force behind the euro was not an economic one. There were plenty of economic arguments rounded up in support, but since they were rounded up without overwhelming thought to their ultimate quality, many proved leaky and met quick criticism from non-partisan economists.
The euro is a political instrument, one more step in stitching Europe together. That, I suspect, is why many of its supporters are not particularly impressed with economic arguments against the euro. Those arguments are seen as beside the point. The US is taken as an example of the benefits of a single currency, but we cannot really know what US economic progress would have been like if the supposed burden of multiple currencies had been offset by the supposed benefits of multiple monetary policies. The dollar served as glue to bind a continent-wide nation together, as a symbol of federal authority. Pan-Europeanists want nothing less. Thus when soon-to-be EU members drop a link to the dollar, I suspect it is at least partly to make a show to current members of severing ties to another political unit on the way to establishing ties with Europe-that-is-to-be.
Ian Welsh,
I take you point (to Anarchus) on the prospect of a full-employment guy heading the ECB, but is Trichet really that guy? I had the impression he was something of an inflation fighter in his BdF days, a reasonable match for Duisenberg in that way. I though he was simply geographically undesirable to the Germans.
In Britain, the case for joining the Euro has been presented very largely in economic terms since the political case for becoming part of a federal Europe in current circumstances has little popular appeal.
Not only were some economic arguments deeply flawed - like claims from some trade union leaders that home owners buying on mortgages would hugely benefit from lower interest rates in the Eurozone without mentioning the knock-on effect on house prices - but economic developments in the Eurozone, especially in the larger economies, have become even less auspicious since the launch of the Euro in January 1999.
On the political side, Brits are the least enthusiatic members of the EU and among the most sceptical about the benefits of membership as the latest official Eurobarometer shows: http://europa.eu.int/comm/public_opinion/archives/eb/eb58/eb58_highlights_en.pdf
The fact that the EU Commission's treasury accounts have not been audited for years does little to foster political confidence, perhaps especially with bland assurances from Commissioners that there is nothing untoward for us to concern ourselves about. That rather has a hollow resonance when all EU Commissioners were obliged to resign in March 1999 following an adverse report of an expert panel on allegations of maladministration, fraud in spending and nepotism.
>I take you point (to Anarchus) on the prospect of a full-employment guy heading the ECB, but is Trichet really that guy?
Part of the answer to that question is here: http://news.bbc.co.uk/2/hi/business/2629585.stm
Strikes me that this analysis is bass-ackwards. Surely an equally productive way to look at this would be to say that the recession in Germany has allowed interest rates to remain low and stimulate growth in France, Spain and Ireland? Seems to me that the Euro has worked fantastically well, in trading off economic problems in an old manufacturing region to stimulate new technology and service industries elsewhere in the zone. Which is exactly what the dollar and pound sterling did not so long ago.
Posted by: dsquared on January 27, 2003 12:38 PM“The dollar served as glue to bind a continent-wide nation together, as a symbol of federal authority. Pan-Europeanists want nothing less.”
Alas, the United States not only had a common language---it decided on a single currency early in its history. The Euro experiment is in some ways a procrustean bed and cart before the horse proposition. Who are we kidding? There is nowhere the unity of purpose in current day Europe as there was between the states that comprised America in the late 18th Century.
There is nowhere the unity of purpose in current day Europe as there was between the states that comprised America in the late 18th Century.
Yeah, the Civil War was actually just this minor disagreement at a dinner party.
Posted by: Jason McCullough on January 27, 2003 06:27 PM"Yeah, the Civil War was actually just this minor disagreement at a dinner party."
Huh? The Civil War started in 1861. The last year of the 18th Century was 1799. Did you perhaps flunk first grade math?
Posted by: David Thomson on January 27, 2003 08:39 PM“A single currency implies resolution of enormously important political and social issues. One must ask if those Europeans who cite the example of America's union have examined the American record of struggle over central banks and single currencies, which lasted from 1790 until 1913.”
http://www.iht.com/IHT/WP/97/wp061897.html
Admittedly, however, the United States didn’t exactly resolve all of its single currency issues until 1913. I guess that this might mean the Euro will have its troubles for the rest of this century.
Posted by: David Thomson on January 27, 2003 09:02 PM>>Huh? The Civil War started in 1861. The last year of the 18th Century was 1799. Did you perhaps flunk first grade math?
Jason's comment is perfectly clear and you should not be so bloody rude, David. He is pointing out that the fact that the economic tensions which led to the Civil War were every bit as real as anything you can point to in Europe.
It is perhaps an interesting exercise to surmise what might have happened if the South had been allowed to float its currency relative to the North; would they have needed to be so dependent on slave labour?
Posted by: dsquared on January 27, 2003 11:45 PM>>the recession in Germany has allowed interest rates to remain low and stimulate growth in France, Spain and Ireland? Seems to me that the Euro has worked fantastically well, in trading off economic problems in an old manufacturing region to stimulate new technology and service industries elsewhere in the zone.
Would that this were so Daniel. This could in fact be true INSIDE Germany, but for the rest? Look at the internet take up rates in the Mediterranean countries if you are in any doubt. As for Spain, post the Argentina crash and the stock market haemorrage above-par growth here is, I'm afraid, a thing of the past. The only thing cheap interest has done is produce a generalised contempt for cash, an acceleration in popular inflation expectations, and an enormous property and housing boom which makes profits on normal business activity look ridiculously small in comparison. This has converted most commercial companies into what are effectively property companies, borrowing - at the cheap, below inflation rates - on increased land values to meet short-term liquidity needs. Meantime the rapidly rising Euro is about to deal a heavy blow to the tourist industry. For those of you who missed the Argentina show, watch out there'll soon be a European remake.
Posted by: Edward Hugh on January 28, 2003 02:21 AMIt's a nice theoretical point about whether slavery might have been a less attractive commercial proposition at the time had the southern states in America been able to depreciate their Dollar against a separate Dollar for the northern states.
I'm much less impressed with some hints here and elsewhere that because the US economy is a successful economy with a single currency, introducing the Euro is therefore bound to be a good idea too. The US economy developed with a single currency from when most economic activity was in agriculture and services and with a federal government already in place.
Imposing a single currency across a collection of independent nation states, each with its own mature, industrialised economy, an established set of market intitutions and a national government with existing fiscal arrangements and laws is an entirely different proposition. If a single currency is such a good idea, why is no one pushing for a single currency for NAFTA or, better still, a single world currency? Edward's post about what has happened in Spain with loss of national monetary autonomy is a good starting point.
As I recall, in early 1999, shortly after the launch of the Euro, La Fontaine, then German finance minister, set out proposals to limit the exchange rate flexibility of the Euro against the US Dollar and the UK Pound. But the US and British governments would not have it, rightly so IMO.
It may be of some wider interest here to see uncorrected reports of evidence on the Euro submitted to the UK's House of Commons Treasury Select Committee at: http://www.publications.parliament.uk/pa/cm/cmtreasy.htm
With the proclivities of UK contributors here tending towards the sceptical, it's perhaps of special interest to see reported evidence from some top-line UK journalists favouring Britain joining the Eurozone at: http://www.publications.parliament.uk/pa/cm200203/cmselect/cmtreasy/uc187-ii/uc18701.htm
However, it can be noted that evidence from other top-line journalists at other hearing sessions tends to the sceptical. One session reports evidence from Sir Edward George, Goveror of the Bank of England, with some of his senior colleagues, including Mervyn King, who will become Governor later this year when Sir Edward retires. Mr King at one time held a professorial appointment in economics at the LSE before becoming the Bank's chief economist and, later, the Deputy Governor.
Posted by: Bob Briant on January 28, 2003 04:53 AMFor a recently distributed IMF working paper of 23 Jan on: Market Predictability of ECB Monetary Policy Decisions: A Comparative Examination - see: http://www.imf.org/external/pubs/ft/wp/2002/wp02233.pdf
Posted by: Bob Briant on January 28, 2003 06:58 AM"It is perhaps an interesting exercise to surmise what might have happened if the South had been allowed to float its currency relative to the North; would they have needed to be so dependent on slave labour?"
I am not buying this theory. The South was seduced by the silliness of Agrarianism and an intense hostility toward modernization and industrial growth. Slavery acts like a narcotic---and soon your economy is similar to the proverbial frog that is unaware that it is slowing being boiled alive. The idiot plantation owners laughed at the salesmen who offered them time saving equipment. They sarcastically replied that they didn’t need to become more efficient because of their inexpensive slaves. In the long run, this always proves disastrous. To be really blunt, The North had its gung ho entrepreneurs while the South had its lazy white establishment racists sitting around all day drinking mint juleps
Posted by: David Thomson on January 28, 2003 07:15 AMOne of Britain's EU Commissioners has gone on record as saying there will be no referendum in Britain on joining the Euro this year - see: http://news.bbc.co.uk/1/hi/uk_politics/2703517.stm
That will give them longer to sort out the institutional and policy framwork for the Eurozone although present indications are that there will be no change in the fiscal deficit limits in the Stability and Growth Pact even if there is greater latitude in interpretation of the period over which fiscal balance in national budgets is required.
The strengthening Euro in the foreign exchange markets should make it easier for the European Central Bank to cut interest rates without increasing inflation but it will also increase the pressure for deregulation in those national economies with schlerotic markets. That said, it remains doubtful whether Eurozone economies, institutions and markets have evolved to the extent where the strains and stresses from a one-size-fits-all monetary policy will abate sufficiently for Britain to join without inflicting unacceptable harm to economic stability. The Eurozone monetary union has yet to prove it can sustain good economic performance in the absence of political unification to ensure fiscal coordination and provide basic automatic stabilisers.
In all the public debates on Britain joining the Eurozone there is a noticeable gap on the mechanics for joining and as to how the entry exchange rate for the Pound is to be decided. There seems to be a tendency in places to regard those issues as mere incidentals instead of fundamental.
"There seems to be a tendency in places to regard those issues as mere incidentals instead of fundamental."
The utopian mindset prefers to ignore reality. Why let a few discomforting facts get in the way of a nice fantasy? Hey, I want to believe that I can go one on one with Shaq O’Neal. Why should I concede that he is about a foot taller and over two hundred pounds heavier than me?
Posted by: David Thomson on January 30, 2003 10:09 AMUpdate for those still following this thread: The Financial Times reports that, "Britain would have to rejoin the exchange rate mechanism if it decided to scrap the pound, a European Commission official told MPs yesterday [6 February]. . ."
- source: http://www.no-euro.com/mediacentre/dossiers/display.asp?IDNO=1085
This and the implications for Britain are worth tracking through but the (uncorrected) minutes of evidence to the House of Commons Treasury Select Committee have as yet not been posted at: http://www.publications.parliament.uk/pa/cm/cmtreasy.htm
Posted by: Bob Briant on February 7, 2003 06:31 AMThe UK Treasury has today published a report on Economic Reform in Europe, accessible in PDF format at this link: http://www.hm-treasury.gov.uk/documents/international_issues/european_economic_reform_white_paper/int_eerwp_index2003.cfm
For an early report in UK media: http://news.bbc.co.uk/1/hi/uk_politics/2772791.stm