The One-Size Euro Mightn't Be So Tight After All

ECB easing means that more countries are closer to an ideal exchange rate

It's a given that the euro can't have the right exchange rate for all of its 19 diverse members, all of the time. Yet at the helm of the European Central Bank, Mario Draghi may be making it a closer fit for more countries, more of the time.

Angel Talavera, an economist at Oxford Economics in London, has calculated for Bloomberg Benchmark what would have been the “equilibrium” exchange rate for 8 euro-area economies between 2011 and 2015 − the rate that would be best suited to an economy's domestic and external profiles.

As the map shows, Germany's economic strength and positive balance of payments would warrant the euro trading at around $1.40, while Greece's woes would require it to be below parity with the dollar. At the beginning of Draghi's term, the euro was too strong for pretty much everyone, and has typically aligned itself more to the needs of “core” economies, Germany included. That hasn't been helpful.

“What would normally happen with a country that has its own currency is that the currency will appreciate or depreciate over time to help correct those imbalances,” Talavera said. “In the case of the Eurozone obviously you can’t have both things happening, so those imbalances are not correcting, but rather amplifying most of the time.”

His calculations bear this out. At the height of the sovereign-debt crisis in 2011 the spread between the optimal rate for Germany and Greece was $0.32. By the end of last year the gap had widened to $0.42. 

But things are changing. The ECB's more recent policies have weakened the exchange rate more toward what would be appropriate for countries like Italy or Spain. Since the announcement of negative rates in June 2014, the euro slid by almost 20 percent against the dollar. While that's still too strong for Greece, it's closer to the average.

The average spread between countries' optimal rate and the actual euro level has fallen from $0.25 at the beginning of 2011 to $0.14 at the end of 2015.

Given the structure of the euro, though, there may be only so much that the current set of policies can do. According to Talavera's Oxford Economics study, the ECB's monetary policy has always been plagued by a paradox: while it has has been “generally right for the common currency area as a whole, it has proven to be wrong for most of its individual members most of the time.”