OXFORD – With the election of a reform-minded centrist president in France and the re-election of German Chancellor Angela Merkel seeming ever more likely, is there hope for the stalled single-currency project in Europe? Perhaps, but another decade of slow growth, punctuated by periodic debt-related convulsions, still looks more likely. With a determined move toward fiscal and banking union, things could be much better. But, in the absence of policies to strengthen stability and sustainability, the chances of an eventual collapse are much greater.
True, in the near term, there is much reason for optimism. Over the past year, the eurozone has been enjoying a solid cyclical recovery, outperforming expectations more than any other major advanced economy. And make no mistake: the election of Emmanuel Macron is a landmark event, raising hopes that France will re-energize its economy sufficiently to become a full and equal partner to Germany in eurozone governance. Macron and his economic team are full of promising ideas, and he will have a huge majority in the National Assembly to implement them (though it will help if the Germans give him leeway on budget deficits in exchange for reform). In Spain, too, economic reform is translating into stronger long-term growth.
But all is not well. Greece is still barely growing, after experiencing one of the worst recessions in history, although those who blame this on German austerity clearly have not looked at the numbers: with encouragement from left-leaning US economists, Greece mismanaged perhaps the softest bailout package in modern history. Italy has done far better than Greece, but that is a backhanded compliment; real income is actually lower than a decade ago (albeit it is hard to know for sure, given the country’s vast underground economy). For southern Europe as a whole, the single currency has proved to be a golden cage, forcing greater fiscal and monetary rectitude but removing the exchange rate as a critical cushion against unexpected shocks.
Indeed, part of the reason the United Kingdom’s economy has held up well (so far) since last year’s Brexit referendum is that the pound fell sharply, boosting competitiveness. The UK, of course, famously (and wisely) opted out of the single currency even as it is now moving (not so wisely) to withdraw from the European Union and the single market entirely.
It is now fairly obvious that the euro was not necessary to the success of the EU, and instead has proved a massive impediment, as many economists on this side of the Atlantic had predicted. Eurocrats have long likened European integration to riding a bicycle: one must keep moving forward or fall down. If so, the premature adoption of the single currency is best thought of as a detour through thick, wet cement.
Ironically, by far the main reason why euro adoption was originally so popular in Southern Europe was that back in the 1980s and 1990s, ordinary people longed for the price stability Germans enjoyed with their Deutsche Mark. But, while the euro has been accompanied by a dramatic eurozone wide fall in inflation, most other countries have managed to bring down inflation without it.
Far more important to the achievement of price stability has been the advent of the modern independent central bank, a device that has helped dramatically reduce inflation levels worldwide. Yes, a few places, such as Venezuela, still have triple-digit price growth, but they are now rarities. It is very likely that if, instead of joining the euro, Italy and Spain had simply granted their central banks more autonomy, they, too, would have low inflation today. Greece is admittedly a less obvious case; but, considering that many poor African countries have been able to keep inflation well within single digits, one can presume that Greece would have managed as well. Indeed, if Southern European countries had kept their own currencies, they might never have dug as big a debt hole, and would have had the option of partial default through inflation.
The question now is how to maneuver the EU out of the wet cement. Although many European politicians are loath to admit it, the status quo is probably not sustainable; eventually, there must be either significantly greater fiscal integration or a chaotic break-up. It is astonishingly naive to think the euro will not face further real-life stress tests over the next 5-10 years, if not sooner.
If the status quo is ultimately unsustainable, why are markets so supremely calm, with ten-year Italian government bonds yielding less than two percentage points more than Germany’s?
Perhaps the small spread reflects investors’ belief that outright bailouts are eventually coming, however much German politicians protest to the contrary. European Central Bank purchases of periphery countries’ debt already constitute an implicit subsidy, and discussion of Eurobonds is heating up with Macron’s victory.
Or perhaps investors are gambling that the South has walked too far into the cement to get out. Germany will just keep squeezing their budgets in order to ensure that its banks are repaid.
Either way, eurozone leaders would be better off taking action now, rather than waiting for the single currency’s next moment of truth. How long today’s optimism lasts is for Macron and Merkel to decide. Kenneth Rogoff, a former chief economist of the IMF, is Professor of Economics and Public Policy at Harvard University.
By Kenneth Rogoff