Anna J. Schwartz - Research Associate, National Bureau of Economic Research
Published December 1, 2001 | December 2001 issue
Editor's Note: Eight years ago The Region interviewed Anna Schwartz, at which time the eminent monetary economist cast doubts about the viability of a unified European currency. Now, three years after the introduction of the euro, and on the verge of the new currency's disbursement into the economy, we asked Schwartz to revisit her views.
What strikes an observer as the date approaches for residents of 12 European nations to turn in their national currencies for euro coins and bills is that the political elites who devised the project to establish the European Monetary Union chose not to give the masses in these countries the opportunity to vote on whether they were willing to surrender their national monies for an untested supranational currency.
The German public has been regarded as the most reluctant among the EMU masses but is said to have been placated for the loss of the mark by the location of the European Central Bank in Frankfurt and the modeling of its structure on the Bundesbank. This is conjecture. The rejection by Danish voters of the euro in October 2000 confirmed the elites' belief that a democratic debate risked the achievement of political union through economic integration and monetary union.
For political elites, the end justified the means. That is why they did not provide for exit from the monetary union. Should a member country decide to leave the union, it will have to introduce a brand new currency on its own. This is a departure from earlier experience. When currency boards were the monetary regimes of colonial countries, they issued their own currencies backed by the colonial powers' money. With postwar independence, the former colonial countries abolished their currency boards, but there was no need to introduce a new currency. They simply continued issuing the local currency as they had in the former monetary regimeoften to inflationary excess. Dollarization, on the other hand, is a monetary regime with no exit comparable to the European Monetary Union.
The intention of the elites is to extirpate the sentimental attachment of the average citizen to his native currency and his native lifestyle. There is something Orwellian in this intention. The elites seek to substitute an attachment to what is European. Humanity on this view is infinitely malleable and Big Brother knows what is best for the average citizen. That is the meaning of the drive for harmonization of the legal, institutional and social framework in Euroland. And this is merely the prelude to the final surrender by the member countries of their political independence to a centralized authority.
Many have commented on the elites' decision to create a common currency before political union. The explanation appears to be a lack of consensus among the elites as to the nature of political uniona federal state or a community of nation states. Hence opting for monetary union seemed less problematic, with political union somehow to follow. Yet political union has historically preceded the creation of a common currency. The European Monetary Union is unique in that the European Central Bank is a single central bank issuing a single currency for politically independent countries. Some believe that the euro as a common currency will foster political union and move Europe away from historically divisive nationalism. In practice, the reverse may well be true.
The elites apparently believe that a common currency engenders sentiments in people that lead them to regard foreigners fraternally. What is the basis for this belief? In monetary history a number of national currencies attained use beyond their homelands because of their reputations as sound monies. Examples include the imperial Venetian gold ducat, used throughout Europe from the 13th to the 18th centuries, the pound sterling before World War I (as described in a well-known passage by Keynes) and the mark and the dollar in our day. There is no evidence that the economic advantage to a holder of conducting transactions with a currency issued by a country other than his own, or hoarding it as a store of value, has political implications. Why then should one expect that the use of euros by a German or a French resident would somehow enlarge their sympathies for the other? Those who urge Latin American countries to dollarize do so because they believe the dollar is sounder than the local currencies, not because they believe the use of dollars will create a political union between those countries and the United States.
The designers of EMU envisaged the euro as a challenge to the dollar's current position as the undisputed premier international currency. To displace the dollar, the euro would need to be known for the stability of its value attested to by its widespread use in foreign trade and international financial transactions. Its role as a store of value, reserve currency, unit of account, medium of exchange, vehicle currency and intervention currency would have to be secure. What the time elapsed since its launch has revealed is that the euro still has to win its spurs.
What is in question is the European Central Bank's credibility. Can it maintain its independence and commitment to price stability, or will it instead succumb to pressures to use monetary policy to achieve low unemployment? It was subject to such pressures this year as economic growth in Euroland faltered and unemployment, after earlier declining somewhat in response to measured labor market reform, began to rise again.
The matter of ECB credibility arises in a broader context that has been acknowledged since the start of EMU. The ECB's common monetary policy is inappropriate for some member countries because on any given date not all members will be in the same phase of the business cycle or face the same structural problem. Those in a recessionary phase would be helped by expansionary monetary policy; those in a business upturn would not. The structural problem relates to the mixture of high and low unemployment levels among member countries. Countries with high unemployment need to reform their labor market rules. Some countries may argue in favor of monetary expansion rather than labor market reform as the way to reduce structural unemployment. How will the ECB respond to dissension among the member countries about monetary policy?
An underlying problem for EMU is that member countries have different preferences with respect to the level of the long-run inflation rate. The Maastricht convergence criteria masked differences in preferences. These differences reflect the degree of pressure each member will face in financing budget deficits. Budget deficits may not present an immediate ground for concern, since there are many restrictions designed to make EU members avoid excessive deficits. The Growth and Stability Pact, in addition, obliges them to limit their budget deficits to 3 percent of gross domestic product and imposes penalties for failure to observe the limit. Budget deficits, however, loom as a real possibility over a longer horizon. The principal source of fiscal overruns over the long term is unfunded commitments by many governments for social security.
Social security expenditures to provide benefits for an ageing population will exceed social security tax receipts. One option for governments would be either to reduce benefits or raise taxes. Governments with a strong preference for noninflationary economic policy will choose this option. Some have embarked on this course. A second option for governments would be to run fiscal deficits with the expectation that the pressure on the federal level to bail them out would be irresistible. The central bank in these circumstances would accommodate inflation, but with increasing disaffection on the part of governments with a preference for noninflationary monetary policy. Can the ECB solve this dilemma?
The enlargement of the European Union to include Central European countries may pose another difficulty for monetary policy. Not all members of the EU share the wish to bring in new members. Relatively less-well-off members stand to lose a share of social and regional transfers to the new poorer countries. Farmers of the present member countries will have to sacrifice some of their subsidies from the Common Agricultural Policy to extend subsidies to farmers of the new member countries. Inflation may seem a cure-all for these tensions. Will the ECB stand firm?
These uncertainties about future ECB performance account for the cautious reception of the euro internationally. The euro will need a credible track record of some duration before it will win acceptance in world financial markets. How well it will succeed in Euroland as a medium of exchange once the public conducts transactions in euro bills and coins will also play a significant part in determining the euro's reputation.