Before the Euro was introduced, each member country had its own central bank that managed monetary policy. After the Euro was introduced, the European Central Bank took responsibility for monetary policy in the Eurozone.
This article by Kevin O’Rourke and Alan Taylor in the latest Journal of Economic Perspectives looks at the internal adjustments needed within the Eurozone in order to get out of the rut where some countries are definitely hurting because they have no independent monetary policy.
They discuss how the United States is a “true” monetary union in the way that Robert Mundell discussed. High internal labour mobility, a common language and the fact that if a state goes bankrupt the Federal government is unlikely to bail it out are key factors that distinguish the United States from the European Union.
Because monetary policy needs to respond to adverse shocks, having a monetary union denies a member state the ability to respond appropriately if there is a shock that affects it alone. Shocks can be distributed asymmetrically across a monetary union – and that means that within that monetary union there can be substantial adjustment problems.
There is an argument that adjustment to macroeconomic shocks in these circumstances should take place by way of internal devaluation. However O’Rourke and Taylor highlight nominal wage rigidity and sticky prices with this brilliant illustration of how hard it can be to adjust wages downwards:
What this shows is the human cost of adjustments after adverse shocks. Look at how many people in Greece are completely screwed – but also look at how when wages can’t be cut because of either refusal to accept pay cuts or labour market rigidities that make it impossible, the number of people employed will plummet in response to the shock anyway.
This paper goes on to discuss how the core European countries are essentially on a different planet in terms of productivity and public service performance relative to the periphery countries like Greece and Spain.
But I do not agree with their argument for a stronger banking union across the European Union. The Euro was always doomed from the start. If you’ve read any French economic history, you’d realise that the politics of the European Union are essentially a cold war between French and German interests.
Whilst Germany has been able to exercise strong influence over monetary policy, France has been a key driver of the vast expansion of the European Union’s bureaucracy and legalistic interference in member countries.
France will eventually go through the reforms that Germany went through in the 1990’s but that may not happen as fast as some people think it will. The idea that completely different cultures could come together to have a single political entity was only successful for the Austro-Hungarian empire which had obedience to the Hapsburgs over silly things like voting in leaders democratically.
Anyway, this is an interest piece that explores the pitfalls of having a monetary union if all of your institutions and financial sector entities aren’t on the same page. It also highlights how money is everything and there are no guarantees of political stability when creditor countries start to force wage cuts on debtor countries. This won’t end well.