The European Monetary Union: ‘Til Debt do Us Part
A monetary union without a concomitant political union is a bit like a marriage without a commitment to monogamy, and not just because both are prevalent among Europeans. The degree to which eurozone states have surrendered sovereignty to Greater Europe is only a partial commitment. By adopting the euro, they have given up monetary sovereignty; individually,
eurozone states cannot print their own money, change their interest rates, or adjust the value of their currency. In other words, these states cannot increase their money supplies in order to stimulate short-term economic growth, they cannot lower their interest rates to spur investment or raise them to halt inflation, and they cannot devalue their currency in order to stimulate exports.
What they have given up in order to share a currency is substantial, but so are the benefits of that shared currency. Primary among them is the lowering of the transaction costs that decrease flows of goods and capital across borders. No longer does Germany trading BMWs to Italy for the latest from
Armani, Versace and Prada involve an exchange of currencies. This greatly lowers both the costs and risk of the trade. Similarly, if BMW opens a factory in Italy, it no longer needs to worry that all of its profits from sales there might be consumed by a depreciating lira (which would buy fewer deutsch marks then when the initial investment in the plant was made). Thus, both intrastate trade of goods and flows of capital in the eurozone have increased substantially since the euro was adopted at the beginning of 2001, despite falling during the recent financial crisis (see: http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=133.TRD.M.I6.Y.M.TTT.I6.4.VAL
But the eurozone states were not willing to jump into the deep end in their commitment to each other. They were only willing to get their feet wet to see if they liked the water (and some of them are liking it less and less of late). This was to be the first step toward a longer-term goal of a much greater commitment: political union.
Partial commitment to anything presents problems. In this case, sharing monetary and exchange rate policies without sharing fiscal (tax and spending) policies makes the success of the former more difficult. In order to join the European Economic and Monetary Union (EMU), wannabe member states have had to achieve the Maastricht criteria. These are a number of criteria related to exchange, inflation and interest rates, as well as government deficits and debt, which are to be kept below 3% and 60%, respectively. However, these criteria present a major commitment problem: prior to joining, states have incentives to meet the criteria, but after they have adopted the euro, there are weaker incentives for member states to continue to meet them. Thus, a number of member governments have deficits and debt levels far beyond those “allowed” by the EMU.
This really should not be a surprise. First, governments have surrendered monetary policy to the European Central Bank and, therefore, only have fiscal policy left to try to stimulate the economy during downturns. Second, there is no current method of automatically penalizing states that
violate the criteria (see: http://www.spiegel.de/international/business/0,1518,724239,00.html).
The data here (http://www.ecb.int/stats/gov/html/dashboard.en.html) show that in 2010, twelve eurozone countries were over the deficit target, with Ireland at 32.4%, Greece at 10.5% and Spain and Portugal at about 9%. Twelve countries are also over the debt ceiling.
This fiscal problem, which has led to the recent debt crisis in Greece and similar problems in Portugal and Ireland (two of the major beneficiaries of eurozone membership) in recent years, is indicative of a broader problem in the European integration experiment: the fundamental tensions in trying to have monetary integration without broader political integration, especially with regards to other economic policies.
Imagine, for example, that there is an economic downturn in the United States (that should not be too difficult to do). Let’s further imagine that Michigan is hit harder by this downturn than Texas. Due to political integration among the states that comprise the USA, there will be a kind of natural shift of revenues from Texas to Michigan. Relatively more taxes will be collected in Texas and relatively more spending, on safety nets like unemployment insurance and other government programs, will be in Michigan. This is one of the advantages of the American states having joined in political union.
The need for fiscal integration in order to preserve the extent of European union so far is increasingly on the minds of leaders of both the European Union and European states (see, for example: http://online.wsj.com/article/SB10001424053111904265504576564801620551890.html). What is required is the further surrendering of state sovereignty to Greater Europe. In the short term, there needs to be deficit and debt level criteria with teeth (meaning a firm punishment mechanism). But this means the inability of politicians to respond to calls by their constituents for greater spending during economic downturns, or greater social spending in general.
The benefits of union come at significant costs; however, in the long-run, Europe cannot succeed as a monetary union unless it is also committed to political union.
- Medvedev, IMF chief discuss eurozone debt crisis (sfgate.com)
- Europe’s rescue fiasco leaves Italy defenceless (telegraph.co.uk)
- Live blog: Eurozone crisis (blogs.ft.com)
- Euro stability more important than Greece, says Angela Merkel (guardian.co.uk)
- Tough-talking Germany takes the eurozone to the brink of a break-up (telegraph.co.uk)
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