What’s the future of the euro? on the last few years this young currency has faced immense difficulties; Nevertheless, it continues to be one of the strongest currencies in the world. Last Friday Daniel Gros, Director of the Centre of European Policy Studies and Enrico Perotti, Professor of International Finance, visited room for discussion to talk about the future of a single currency in the European Union. As a follow-up to the introduction article published on Friday, this one serves to present some on the ideas that were shared with the audience.
The idealism of the euro
About twenty years ago, when the euro was first introduced, Italy was undoubtedly one of the main supporters of a single currency within the union. According to Enrico Perotti, this great aspirations did not have a politic or an economic origin, but in fact a cultural one, he states, “I remember discussing with my colleagues the great hope that the euro would finally have germans save us from ourselves… it didn’t quite work that way”. On the other hand, Mr Gros indicated that he believes the monetary union did make economic sense at the time. According to him, it was widely perceived as a way to extend the success of the Germanic model of an independent central bank with low inflation as its predominant objective. This would inherently benefit all the countries by providing stable prices. But as we all know, this was not the case.
Back in early 2000, citizens hoped that the euro would help countries in the southern part of Europe reach the levels of productivity or income in the northern part of the region. However, this was not the case and instead Italy, for example, has witnessed a reduction in the per capita income ever since they joined the union. According to Mr Gros, this was not an issue of the euro since it was explicitly stated that there would be no capital transfers or bailout among the members and that every country would be responsible for the welfare of its own citizens, the only thing that the euro would provide is a stable currency.
The expectation of convergence came from research done in the United States that showed convergence in the country from the 40’s to the 80’s. However, now we know that this was exactly the point at which convergence stopped. And although convergence did occur in Europe for a while it was in most cases based on bubbles or unstable capital inflows. According to Daniel Gros, within the European Union convergence has continued except for countries with weak institutions such as Greece and southern Italy, which have, in fact, diverged since the financial crisis.
What went wrong?
One of the main criticisms from economists is that the European Union does not meet the conditions of an optimal currency area, meaning that it does not present the geographical requirements that would maximize economic efficiency given that the countries do not share full labour and capital mobility or flexibility of wages within countries. However, according to Daniel Gros, this was not the main problem that they encountered, instead, it was that they completely neglected financial markets and their inherent instability.
Moreover, according to Mr Perotti, the deterioration that some economies have suffered since adopting the euro can be attributed to institutional differences. For example, Italy had a system that relied on devaluation to reduce the imbalances created by internal political conflicts, once they joined the euro, they could not devaluate anymore, therefore an internal convergence should have occurred in order to accommodate into this new “rigid” system. However, this is extremely difficult, and much like asking a country to change their culture.
It is important to remember that Italy used to be the second largest manufacturer in Europe. They relied on trade to compensate for their huge deficit spending. According to Enrico Perotti, locking into a monetary union with stronger countries like Germany and The Netherlands, who had historically stronger currencies, meant that Italy was caged into the wrong price and became more and more uncompetitive “from the beginning the monetary union was a transfer union but from the weak to the strong… this can very much explain the decline of Italian performance in the tradable sector”.
On the other hand, according to Daniel Gros, the decline of the Italian productivity occurred before the introduction of the euro, but it is a matter of questioning whether it would have easier to manage this kind of decline with the availability of a floating currency. He points to the deterioration of the quality of governance in Italy which is currently about two standard deviations below the European average in the WGI indicators. In the end, According to Gros, between 90% to 95% of a country’s success is determined at home and only 5% is influenced by the single currency.
In this topic is where we see the views of our two interviewees conflicting the most, according to Mr Gros, if we take a look at the last crisis the countries that took matters into their own hands, such as Ireland were the ones that exited first. While those like Greece who blamed the foreigners are still immersed in it. Instead, Mr Perotti believes that the reason why some countries were more hit by the crisis is than others was due to their level of exposure to the securitization, mortgage markets and bubbles.
In the end, nothing will change if they’re not a deep structural reform within some countries. The European Union could create funds to incentive the growth of some of the members that are lagging behind, but, It is not possible to force the economy of a country to behave the way another one does, even if you provide a complete monetary framework.
Questions from our editors:
With all the current events going on right now in Europe, like the rise of populism, the immigration crisis, Brexit, Spain with Catalonia. Do you think we should expect a weaker or a stronger euro in the future?
It will all depend on how Italy will perform during the next years because this will be an indicator if the single currency and the EU actually can change something and even whether it has a use or not.
Thinking about the increase of cryptocurrencies, like Bitcoin, do you think this will have an impact within the next years (decade), on the Euro and its strength?
Cryptocurrencies are just a bubble that will eventually pop, most likely within the next few years. They won’t have any influence or impact in policymaking or monetary behaviour.