One Size Fits None: Understanding the Euro’s Structural Mismatch
The Euro is often praised as a symbol of economic unionism, but in reality, its use divides the economies within its scope. The Euro was launched into circulation in 2002 in order to create a common currency and monetary policy across Europe. From its inception, it was designed to deepen economic integration, eliminate currency risks and fluctuations, and reduce friction on intracontinental trade and labor mobility. However, with all countries in the Eurozone having vastly different underlying economic structures, and by removing the advantages of having their own national currency, the Euro fails the countries under its umbrella.
Policy Tools Under Monetary Independence
The primary advantages of having a domestic currency are driven by the potential to appreciate or depreciate it depending on the current economic situation. Countries may choose to depreciate their currency to increase export attractiveness, or they may appreciate it to reduce the cost of foreign debt or combat inflation. Having control over your own currency often implies oversight over the monetary policy, as a country’s central bank will modulate interest rates to fit the respective long term objectives of its state. This also means that when a country issues debt, it has a lender of last resort which materially reduces the default risk on issued debt.
In the Eurozone, all countries share a single currency, along with one unique interest rate, all overseen by one central bank. For instance, some countries, like Spain, are deeply indebted and rely on services and real estate for a large portion of their GDP, others, like Germany, are able to maintain a surplus due to the sale of high-end automobiles. This directly creates dysfunction with a state's monetary needs and the current state of its currency. Countries which produce high-quality goods but import most of its raw materials, like Germany, would benefit from a stronger currency. In comparison, a country where tourism is its main economic driver, like Greece, would benefit from a relatively weaker currency in order to boost production by decreasing the price of services to foreigners.
Divergent Business Cycles Under a Single Interest Rate
This inability to tailor monetary policy to a single country's own economy is mainly what drove Spain and Ireland into worse economic conditions following the Great Financial Crisis. Within the eurozone, one interest rate is set to cover the needs of all countries, but because the respective states all have different business cycles, this could lead to potential asset bubbles or stronger recessions. The European Central Bank’s (ECB) single interest rate is unevenly low for countries that are experiencing growth, which ought to increase the cost of borrowing to slow activity, and excessively high for those that are experiencing a recession. Nevertheless, the majority of macroeconomic policies have been under the control of national governments, leading to idiosyncratic movements that are not regulated by the existence of a unified currency. As seen in Italy in 2011, entering recessionary conditions and with monetary easing anticipated, the ECB tightened policy in response to northern European inflation, deepening Italy’s country-specific financial stress. Consequently, within the monetary union, only certain rare situations can induce the convergence of booms and crashes at the Eurozone level. As a result, booms and collapses solely exist at the national level, rather than forming a common boom-and-bust dynamic at the Eurozone level. This makes it even more detrimental, as the ECB can never take action to solve a problem that the entire eurozone is facing.
Crisis Dynamics and Internal Devaluation
In Ireland and Spain, the interest rates were under 3% in the early 2000s because high production level countries, like Germany, put downward pressure at the interest rate to be set at a lower level than what would have been adequate for both Spain and Ireland. In Spain specifically, individuals were borrowing heavily in order to capitalize on the booming real estate market. Their national production could not keep up with the expected price level, and the asset bubble burst during the 2008 financial crisis. A country in control of its interest rate could have tightened its lending to flatten the boom. However, with the adoption of the Euro, Spain had given up their economic sovereignty.
Without the ability to devalue your own currency, the country's economy must resort to internal devaluation. Inflation is frequently used by governments as an instrument to assist businesses in paying their employees, hence preventing layoffs. This is because a salary which remains stable throughout the years, in regards to increasing inflation, becomes less of a financial burden for employers. In the absence of controlled inflation levels to help employers in maintaining nominal wages during financial distress, while real wages experience a modest decline, companies are forced to make job and wage cuts. This can be seen in Spain, where the unemployment rate reached 24.6% in the spring of 2013. The Spanish government had to issue debt in a currency that it did not control, where it lacked the possibility to guarantee repayment. In June 2012, the Spanish 10-year government bond reached 7%, 5.44% over the German 10-year bond. Spain's economic minister even travelled to Germany to request that the ECB facilitate government bond purchases to avoid an impending economic disaster. A similar situation also happened in Greece, where 10-year bond yields increased over 30% in 2012.
Future Issues and Summary
Although Spain has made a partial recovery with the help of Eurozone rescue loans and more flexible employment regulations, the problems associated with a one-size-fits-all currency are still looming. Italy has seen yearly GDP growth of less than 0.4% for the better part of the last decade and a public debt equal to 140% of GDP. Currently, the country is facing increasing recession danger, as it lacks its primary tool to stop it. The ECB is expected to raise interest rates to satisfy northern European countries; however, this may adversely impact Italy, which desperately needs a loosening of monetary policy. In conclusion, integration for the sake of integration brings no real benefits. Solidarity with the euro should not rest on a policy framework that is harmful to its nations, and the current situation fails to reflect the real differences and needs across member economies.