Monetary Union Might Just Put The Spring Back In Europe's StepRudi Dornbusch
Progress toward creating the European Monetary Union (EMU) continues. Italy and Spain have just decided to join, making for a Western European-wide union rather than a mere German-French deal. But three important questions remain. Can the union be realized on time? Will it revive Europe's sick economies? And what will it do to the U.S. and the dollar?
The Maastricht Treaty, which calls for monetary union by 1999, requires that Europeans gather soon to decide who's in and who's out. The criteria are clear: Budget deficits must be below 3% of gross domestic product; public debt-to-GDP ratios must be below 60%; inflation has to be low; and exchange rates must be stable.
A lot of interior decorating is going on: The French, Italians, and Germans are all fudging their budgets to hit the goals. The inflation target is no issue because Europe has already converged toward a near-zero inflation rate. Far trickier is the debt ratio. Belgium can't hope to meet the target. And Italy has a 120% debt ratio, double what is allowed. Fortunately, Maastricht allows some flexibility, or so the Italians say.
Currently under negotiation is an agreement on how to discipline countries to keep their deficits in line once they are in the monetary union. The provisions are unusual. They include heavy penalties and external surveillance--the price for winking at deficit levels. The rationale is that if deficits are small, then debt ratios will come down.
LOCK IN GAINS. Starting on Jan. 1, 1999, the currencies of member countries will be linked with fixed exchange rates, and the European Central Bank (ECB) will run monetary policy for the entire monetary union. The ECB will be independent from governments, with a strict mandate of price stability. The first president is likely to be Dutch central banker Wim F. Duisenberg, a tough monetarist. By 2002 a common currency replaces German marks, French francs, guilders, etc.
The whole enterprise is highly experimental. The EMU project is driven by politicians. Given Germany's history, Chancellor Helmut Kohl wants to merge Germany into Europe to prevent trouble in the years ahead. Elsewhere, finance ministers who have fought to bring down inflation and deficits want to lock in their gains and avoid the temptation to inflate their way out of high unemployment. Industry sees the EMU as widening the European market, creating opportunities for restructuring and modernization. And German banks smell an opportunity to become dominant in the integrated financial community. Finally, the man in the street is vaguely enthusiastic, but anxious. Germans worry that their precious mark will be debased. The French worry about higher unemployment.
Beneath the haggling lies one clear fact: In 1998, both Germany and France will have elections. Kohl and French President Jacques Chirac want to run on the prospect of a greater Europe. If the EMU now fails, there is no Plan B to take its place. And failure could trigger a round of competitive depreciations. Even if the EMU is a bad idea, not doing it at this stage is much worse.
NO PANACEA. Is it a good idea? In itself, the EMU does little. Not having to change money at the airport is not a big deal. Being able to pay across borders in a single currency does not really help if there is no single language and the phones don't work. This is not the U.S., where you dial an 800 number to shop in California using an Oklahoma operator while sitting in Maine. And with increased trade thanks to the EMU, the trend toward using English in business will accelerate.
There is another way in which a Europe-wide EMU can make a real difference. With monetary and fiscal officials throughout Europe running very tight ships, some confidence and momentum are sorely needed. So perhaps another round of Europeanization will provide the boost, just as the dismantling of internal barriers did early in the decade.
As to the U.S. and the dollar, the European currency will be backed by some of the richest economies in the world, with 400 million consumers. With those credentials, it can compete with the dollar in a way the mark or yen never could. Does that mean the European currency will rise against the dollar? Surely not. Europe already believes the dollar is undervalued. The last thing it will do is push it down further.
So the U.S. cannot lose from the EMU. If it helps Europe grow, that is good for international prosperity. If it disarms the Bundesbank, with its deflationist tendencies, that's even better. If it creates better financial markets in Europe, U.S. investment houses and banks will be big players.