The View from 2008 – Exploiting Europe’s Strong Potential
I just read an interesting paper from 2008 about the Euro’s tenth birthday approaching but with the Euro debt crisis not yet omnipresent. Apart from a few – in retrospective – amusing nuggets:
“The attractions of the euro should be actively promoted in the non-participating member states. This task is becoming easier as it becomes ever more clearly a pole of stability in the global system.”
“Ten years [after the introduction of EMU] later we can rejoice in the success of the euro and can comfortably predict that it is here to stay.”
The paper is insightful and holds up quite well in part of its analysis. Two aspects especially struck me as interesting:
First, the authors point to an inherent trade-off between attempts to raise productivity: “The sequencing of policy implementation must be right. The unemployment rate in the eurozone, albeit diminishing, ist sill relatively high at around 7%. This needs to be fixed before any measure to boost productivity is undertaken. Indeed, the process of job creation reduces productivity, so there is no point in trying to achieve two conflicting targets at once.” In Spain, productivity has actually risen at exactly the cost laid out above though, an unemployment rate of 7% would be good news in most of Southern Europe in fact. Yet, productivity – considering continued low inflation in the core and accordingly the limited impact of nominal wage changes for relative unit labor costs in the South – clearly is one of the most important channels through which a sustainable current/capital account rebalancing could occur (one that is not predominately based on the disappearance of domestic demand that is: see here). It is not clear how this circle could be squared then.
“There is clear evidence pointing to the rising divergence in real exchange rates in EMU. At the root of this divergence are differences in the growth of national price levels. These are not only a function of cyclical positions but are also determined by the shape of national institutions, and of labour markets above all. Yet, labour markets do not operate in a vacuum. Their functioning is often conditioned by the fiscal and monetary policy regime under which they operate. In particular, the monetary policy regime change that came about with the inception of EMU has altered national unions’ incentive structures. As an example of this, coordinated labour markets in large countries are under a stronger incentive to restrain wage growth than their equivalents in small countries. This is because domestic inflation in large countries affects average eurozone inflation and therefore the ECB’s conduct of monetary policy. Germany for instance, has been pursuing a wage restraint policy in recent years, which has resulted into a significantly below-average wage growth and impressive real exchange rate depreciation.”