How to make the euro more sustainable

Close examination of the inflation and output performance of eurozone member states reveals “inherent problems” with the euro that could threaten its long-term existence, claims Mike Wickens of the University of York in a June 2007 paper for EuroIntelligence.

Moreover, he adds that there is “nothing that the ECB (European Central Bank) can do about this.” 

The ECB’s success in maintaining low average eurozone inflation since 2000 suggests that questioning the sustainability of the currency may seem “unwarranted”, concedes Wickens. 

However, a comparison of price and output levels between the eurozone countries suggests otherwise, he reveals – with some countries experiencing large increases and others only small ones. 

Generally, the higher the rate of inflation on joining the euro, the greater the increase in prices, show Wickens’s figures. Moreover, there has been no tendency for inflation rates from country to country either to “converge or diverge” since, reveals the research. In contrast, the UK – outside the eurozone – has produced data similar to the EU average, thus maintaining its competitiveness with the eurozone countries. 

Wickens rejects the “one-size-fits-all” monetary policy as an explanation for these results – because setting a single nominal interest rate for the eurozone implies that high inflation countries will have a low domestic real interest rate and vice-versa. This would result in higher prices in high inflation countries, as well as a divergence of inflation rates. There is no evidence to suggest that any of this is happening, he claims. 

His paper identifies two problems for the eurozone – firstly, that the divergence of price and output levels will eventually threaten the euro’s sustainability, and secondly, that social policy flexibility is the only macroeconomic instrument remaining with which eurozone countries can stabilise their economies. 

Wickens concludes that only by improving the single market for goods, labour and capital, improving productivity and phasing out less competitive industries – as the UK has done – will the eurozone regain its competitive edge. 

He adds that eurozone countries will come under strong pressure to find a “sustainable” solution to their dilemma. Leaving the euro in favour of an independent monetary policy such as the UK’s is one solution but comes at a price – namely higher interest rates. 

The solution lies with “individual countries and EU rules”, and not the ECB, claims Wickens – requiring a “strong commitment to the single market” and “re-fashioned” social rules that offer the flexibility required to achieve economic stabilisation.