The 10th anniversary of the January 1, 1999 launching of the euro is approaching. However, the celebrations are likely to be tempered by the sluggish performance of the 15 European economies that have adopted the euro as their common currency (Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovenia, and Spain) and other countries with currencies pegged to the euro. The prospects for the Eurozone economies have clearly worsened following an unexpectedly strong first quarter.
The euro-skeptics that predicted that the largely political decision to launch the euro would founder in the absence of the economic conditions thought necessary for a common currency area have been proven wrong – at least thus far. On the other hand, it is not evident that the euro has made a significant contribution to the region’s growth or international competitive position. The Bank for International Settlements (BIS) reports that the euro’s role in the foreign exchange market is pretty close to just the sum of its parts (the former national currencies of the Eurozone members). The same can be said of the euro’s share of official reserves.
Our focus in this note is on the region’s economic performance. When a country adopts the euro as its currency, it must cede control over the nation’s monetary policy to the European Central Bank (ECB). Thus the ECB calls the tune for all of the 15 Eurozone economies – from Germany to Malta – and it can not differentiate among these economies. One size of monetary policy must fit all, regardless of the situation in the national economy. A further constraint on policy flexibility is the fact that the ECB has only one policy objective in its mandate – to maintain price stability, which they interpret to mean inflation rates below but close to 2% over the medium term. This does not mean the ECB must ignore economic growth or employment conditions, but combating inflation must be its over-riding priority.
Earlier this year the Eurozone economies were registering healthy growth and economic policymakers were proclaiming that Europe would escape much of the crisis in credit markets and the slowdown underway in the US. The ECB’s single-minded focus at that time on the inflationary threat from surging global prices for oil and other commodities looked appropriate.