June 12, 2008
The euro, once billed by Gerhard Schröder as the most important step towards European integration, celebrates its 10th birthday in June. Since its conception in Maastricht and its 1998 birth, it has come a long way—but what challenges now face the Economic and Monetary Union (EMU) as it moves towards maturity?
The euro’s first decade can be regarded as a definite success: it reduced inflation, dampened inflationary volatility, increased foreign direct investment (FDI) flows, and helped merge financial and business cycles. However, it is now important to look at future challenges that confront the EMU and how well placed it may be to handle them.
The current economic environment is somewhat different from the one in which a nascent euro emerged a decade ago. Globalisation has aided the development of an array of emerging countries which now fuel and drive worldwide economic growth; concurrently, their influence has been augmented by their new found economic strength. Alongside this, the past decade has seen countries become further intertwined with one another —and this trend shows no signs of abating. Only recently has there been an appreciation that the global economy might face a scarcity of key natural resources: while traditional concerns focused on the supply of coal and oil, they now include water, food and even the possibility of carbon emission allowances. This dearth of key resources will inflate prices—and, consequently, present a significant challenge to the monetary policies exercised by the European Central Bank (ECB). Lastly, Europe’s aging population is placing further strain on the public purse of governments across the continent—and also hurting levels of innovation and productivity, thus dampening wealth creation.
The above issues touch on key challenges that face countries across the globe. However, when analysing these problems from a Eurozone perspective, a bespoke set of difficulties emerges.
A central concern in creating the EMU was the effect it would have on limiting a country’s ability to respond to demand shocks as member countries lost their power to alter their exchange rate. Over the past 10 years, this issue did not materialise due to increased levels of stability and a surge in economic growth. But with the economic environment becoming increasingly difficult, and non-EMU countries changing their exchange rates to manage these shocks, those within the EMU face a distinct problem. Demand shocks will impact on each EMU state differently, meaning that EMU members may require different responses. But with the absence of exchange rate controls, those in the Eurozone look set to be facing a bumpy ride in the coming months—as they are all strapped in together with a one-size-fits-all belt.
It is likely that in future years there will be an increase in the frequency of supply shocks; this will have the effect of causing friction between fiscal and monetary policies. Euro members will need to display their willingness to embrace the collective goal of macroeconomic stability by aligning their fiscal policies alongside the ECB’s monetary policies. If the economic environment turns sour, then managing these interests will become significantly harder for both Eurozone governments and the ECB.
The absence of exchange rate controls means it is essential that Eurozone members develop alternative ways to handle possible economic shocks. One mechanism to achieve this is to further harmonise financial markets and promote continued integration. However, in times of economic uncertainty liberalising policies are often sidelined for protectionist measures. It is paramount, though, for those in the Eurozone to maintain levels of integration and continue to harmonise policies so that their economies continue to be aligned, as this will help mitigate the impact of economic shocks on the Eurozone area.
Having demonstrated its strength and promise over the past 10 years, the Euro is now seriously beginning to challenge the US dollar. One welcome consequence is that the Eurozone does not necessary catch a cold when the US sneezes, as the euro has developed its independence. However, this new status as global currency and dollar-challenger status brings with it political considerations as well as heightened economic responsibility, and it must be asked whether the ECB and the Eurozone countries are ready for such responsibility. More answers will become apparent when assessing how well the euro copes with the coming uncertainty and the induction of further countries into the Eurozone.Author : cicero