The Euro: Monetary Unity To Political Disunity?
SAN FRANCISCO - A common
currency is an excellent monetary arrangement under some circumstances, a
poor monetary arrangement under others. Whether it is good or bad
depends primarily on the adjustment mechanisms that are available to
absorb the economic shocks and dislocations that impinge on the various
entities that are considering a common currency. Flexible exchange rates
are a powerful adjustment mechanism for shocks that affect the entities
differently. It is worth dispensing with this mechanism to gain the
advantage of lower transaction costs and external discipline only if
there are adequate alternative adjustment mechanisms.
The
United States is an example of a situation that is favorable to a
common currency. Though composed of fifty states, its residents
overwhelmingly speak the same language, listen to the same television
programs, see the same movies, can and do move freely from one part of
the country to another; goods and capital move freely from state to
state; wages and prices are moderately flexible; and the national
government raises in taxes and spends roughly twice as much as state and
local governments. Fiscal policies differ from state to state, but the
differences are minor compared to the common national policy.
Unexpected shocks may well affect one part of the United States more
than others -- as, for example, the Middle East embargo on oil did in
the 1970s, creating an increased demand for labor and boom conditions in
some states, such as Texas, and unemployment and depressed conditions
in others, such as the oil-importing states of the industrial Midwest.
The different short-run effects were soon mediated by movements of
people and goods, by offsetting financial flows from the national to the
state and local governments, and by adjustments in prices and wages.
By
contrast, Europe’s common market exemplifies a situation that is
unfavorable to a common currency. It is composed of separate nations,
whose residents speak different languages, have different customs, and
have far greater loyalty and attachment to their own country than to the
common market or to the idea of "Europe." Despite being a free trade
area, goods move less freely than in the United States, and so does
capital.
The European
Commission based in Brussels, indeed, spends a small fraction of the
total spent by governments in the member countries. They, not the
European Union’s bureaucracies, are the important political entities.
Moreover, regulation of industrial and employment practices is more
extensive than in the United States, and differs far more from country
to country than from American state to American state. As a result,
wages and prices in Europe are more rigid, and labor less mobile. In
those circumstances, flexible exchange rates provide an extremely useful
adjustment mechanism.
If
one country is affected by negative shocks that call for, say, lower
wages relative to other countries, that can be achieved by a change in
one price, the exchange rate, rather than by requiring changes in
thousands on thousands of separate wage rates, or the emigration of
labor. The hardships imposed on France by its "franc fort" policy
illustrate the cost of a politically inspired determination not to use
the exchange rate to adjust to the impact of German unification.
Britain’s economic growth after it abandoned the European Exchange Rate
Mechanism a few years ago to refloat the pound illustrates the
effectiveness of the exchange rate as an adjustment mechanism.
Proponents
of the "Euro" often cite the gold standard era from 1879 to 1914 as
demonstrating the benefits of a common currency. But the gold standard
also had its costs. The period was characterized by declining prices
from 1879 to 1896, rising prices thereafter, and sharp fluctuations
within each period, especially severe in the 1890s. The standard was
viable only because governments were small (spending in the neighborhood
of 10 percent of the national income rather than 50 or more percent as
now), prices and wages were highly flexible, and the public was willing
to tolerate, or had no way to moderate, wide swings in output and
employment. Take away the rose-colored glasses and it was hardly a
period or a system to emulate.
As
of today, a subgroup of the European Union -- perhaps Germany, the
Benelux countries, and Austria -- come closer to satisfying the
conditions favorable to a common currency than does the EU as a whole.
And they currently have the equivalent of a common currency. Austria and
the Benelux three have, to all intents and purposes, linked their
currencies to the Deutschmark. However, these countries still retain
their central banks and hence can break the link at will. Any country
that wishes to link to the Dmark more firmly can do so on its own,
simply by replacing its central bank with a currency board, as some
countries (such as Estonia) outside the EU have done.
The drive for the Euro has been motivated by politics not economics. The
aim has been to link Germany and France so closely as to make a future
European war impossible, and to set the stage for a federal United
States of Europe. I believe that adoption of the Euro would have the
opposite effect. It would exacerbate political tensions by converting
divergent shocks that could have been readily accommodated by exchange
rate changes into divisive political issues. Political unity can pave
the way for monetary unity. Monetary unity imposed under unfavorable
conditions will prove a barrier to the achievement of political unity.
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