Photographer: Akos Stiller/Bloomberg

The Euro Is Drifting Apart and the End of QE Could Worsen It

  • Data on incomes, wages and employment show convergence stalled
  • End of ECB stimulus threatens to worsen economic disparity

Twenty-five years ago, when plans for the euro were formally set down, an unofficial promise was made: Bring this currency to life, and the economies that use it will grow together.

That hasn’t happened. And now, as the region’s growth solidifies, the process of “convergence” -- an aligning of economic outcomes -- may yet be thrown further back when the stimulus being supplied by the European Central Bank eventually stops.

“The euro area’s travails are largely due to lack of effective convergence, both before the financial crisis and since then,” the ECB’s Benoit Coeure said last month in a speech in Maastricht, where the treaty creating the single currency was signed in 1992.

The currency bloc, now made up of 19 nations, is more than three years into a growth phase that’s helping to heal some of the scars of the crisis. Data this week showed euro-area economic confidence rising for a sixth straight month, youth unemployment falling to an eight-year low and inflation accelerating to the fastest pace since January 2013.

A composite Purchasing Managers’ Index climbed to 56.0 in February from 54.4, putting the region on track for quarterly growth of 0.6 percent, IHS Markit said on Friday.

The following charts however suggest an answer to a broader question that was asked long before Maastricht, in debates that helped forge the single currency’s design in the 1960s: Can economies grow together because of a shared currency, or must they show convergence first in order for that currency to work?

The so-called Economists group -- including Dutch central bankers and then-Bundesbank president Karl Blessing -- argued that countries needed to enact similar policies and have similar outcomes in terms of prices, budget balances and so on before sharing the same currency. In the end, they lost to the argument made by the French-led Monetarists, who claimed monetary union would in itself eventually lead to convergence.

A quarter century later, be it in terms of gross domestic product per person, wages or unemployment, euro-area countries haven’t grown closer. The mere existence of the euro hasn’t, in the end, been enough to drive countries together. And as governments haven’t pursued that goal strongly enough, the region has even drifted further apart.

It’s worth remembering that in fact it wasn’t disparity in incomes that accelerated the drive to the euro. As well as a political desire to deepen European integration, it was to a large extent a response to the financial and currency turbulence that came after the Bretton Woods system ended in the 1970s. And in terms of financial convergence -- the availability and price of credit everywhere -- there was considerable progress, only for that to be reversed by the sovereign debt crisis.

The process of recovering from the crisis hasn’t finished yet, and is vulnerable to reversal once the ECB’s 2.28 trillion-euro ($2.4 trillion) quantitative-easing program ends, according to Nick Kounis, head of macro research at ABN Amro Bank NV in Amsterdam. The program is due to run until at least December.

“The ECB has papered over the cracks, it has kept the euro zone together under serious risks and can’t continue forever,” Kounis said. “It stepped into a leadership vacuum, but there will come a day when they will have to step back and then risks will rise again.”

Sizable divergence still exists despite everything the central bank has done -- a sign that government policies haven’t borne the same burden. For instance, unit labor costs, a measure of competitiveness, were more than 25 percent higher in Italy than Germany before the crisis -- it was still 18 percent higher last year, despite unemployment being more than twice the German rate. Unemployment levels are converging once more, but there’s a long way to go.

“The ECB’s monetary policy has helped narrow the gap that opened up since the crisis,” said Marco Valli, an economist at Unicredit SpA in Milan. “But structural divergences in the euro area have not disappeared.”

The risk, Valli says, is that some of the cyclical progress of the recent past can be reversed when monetary stimulus starts being reduced. At a time of growing disillusionment about European integration, divergence may feed into populist arguments that people’s interests are better served if sovereignty returns at the national level.

That’s an issue citizens can feel in their pockets. In recent years, salaries in real terms have stagnated or fallen in periphery countries and only slowly started rising in core countries. In the end, monetary policy can’t, or won’t, drag the worse-performing euro members up, according to Fabio Balboni, an economist at HSBC in London.

“There has been more divergence than convergence if you look beneath the surface of quantitative easing,” Balboni said. “The issue going forward is whether the ECB will be able to justify continued stimulus only on account of the weakest members.”

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