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Answer to question 3 Continued.
Noone knows for sure what will happen. It is an unprecedented experiment in recent times for 12 states to have a single currency. There have been such experiments in the past century. In Germany there were several abortive monetary unions before Bismarck united Germany under Prussia. There was also a Latin Monetary Union in 1865 using the French Franc, and comprising France, Italy, Belgium, Switzerland, Greece and the Papal States; this ran into trouble quickly and was formally dissolved 30 years later. People say the Gold Standard, from which modern currencies evolved and which was formally ended after the second world war, is a parallel; but in fact any state could at any time withdraw or change the Gold Standard rules, relating the amount of its own coinage or currency it circulated to the gold it held in state vaults. So it was a voluntary, malleable arrangement- unlike monetary union from which there is supposedly no exit. Of course monetary union could in practice be dissolved or a country could leave it; noone expects the other members to force it back into the union by force, as the North of the USA forced the South back during the Civil War. This means that in the absence of a single state to enforce participation the euro is vulnerable to instability and uncertainty; a single currency really does need a single state.

The biggest practical problem for the euro is managing monetary policy, in other words setting interest rates and so by implication the level of the euro's exchange rate against other currencies, especially the dollar. By having a single currency the 12 members must also have a single interest rate and of course a fixed unit of exchange against each others. Since an Italian Euro is the same as a Belgian euro the interest rate you will get on an Italian bank deposit will be the same as what you will get on a Belgian bank deposit; if it were not people would switch between them massively until the banks were forced to offer the same. But having the same interest rate and exchange rate for all the very disparate parts of the euro area, from relatively fast-growing parts (like Ireland in 1999) to stagnant East Germany, is full of problems.

It is bad enough managing the different regional needs of a single country with a single currency; think of the way that in the late 1990s the North of the UK attacked the strong pound and high interest rates because of their effect on manufacturing while the South was enjoying a service-dominated consumer boom which needed those things to control it. We cope with these strains in the UK in a lot of complicated ways; we help regions in trouble by a national system of taxes and benefits that automatically transfers more money to them, their MPs scrutinise policy generally to see how else they can be helped, then people are free to move from region to region, and finally we have developed a flexible, competitive labour market so that wages respond flexibly to regional problems.

Are any of these mechanisms available in the euro area? In fact, basically none of them. When these strains develop in response to shocks, like regional recessions, the burden will entirely be on the European Central Bank to adjust the euro-wide interest rate and exchange rate. This adjustment could be right for the average region but it will be too tight for the regions in recession and too loose for the regions that are still doing well. The lack of regional monetary flexibility will add to the size of recessions and of booms in every region.

This might be less of a problem if all the economies of continental Europe were in good shape; then a bigger boom-bust cycle could be taken in its stride, perhaps. But unemployment on the continent is on average over 8%; it is (mid2002) 9.9% in Germany, 9% in France, 9% in Italy and 11.3% in Spain, against 5.2% here (3.1% on the claimant count), and while that means the bigger booms will be welcomed, it also means that the deeper recessions could take unemployment up to unheard of peaks, like 20%. When on top of that Europe's citizens are paying high taxes and facing the probability of yet higher taxes in the future to deal with their states' financial problems, the prognosis for the Euro's popularity with the ordinary citizen appears problematic, to say the least.

The economies of continental Europe had been recovering in 1999 from their recessions of 1996-7 and in spite of the threats from the Asian crisis enjoyed inside the euro an initial honeymoon period, assisted by a large fall in the euro's value, which aided their trade performance. But a system must last through foul as well as fair weather. In fact the pressures of thecurrent slowdown in 2002 like those of the 1997/8 Asian Crisis have creatd a wide divergence in growth and inflation across the euro-zone.This is the very divergence about which European politicians were warned when considering bringing in the euro.

Until the euro has passed the test of a serious and divergent recession, it will be unwise to say it has the robustness to survive and be accepted by the peoples of Europe who have not been consulted but are democracies for all that. They may have the will to accept the system, warts and all, for political reasons; and try to make it work, probably through closer and closer political union. If so, that will be their privilege and choice. We must remember that for many on the continent- in Spain, Portugal, and Italy for example- there is great dissatisfaction with their previous systems of government, whether from their perceived incompetence, or corruption, or lack of democratic responsiveness to the people's wishes; for them Europe seems to be a great opportunity to build a new future. We should not get in the way of their wishes; but then again, we should not assume that what might suit them politically, also suits us.

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© Patrick Minford 2002