Summary:
Mike Wickens (York). Argues introduction of euro has not achieved its goals. Inflation rates have not diverged, but ouput and inflation are not converging. Problem with a one-size-fits-all policy. In part due to inflexibility in fiscal policy imposed on members, in part due lack of labour mobility. Single market legislation has produced single market in goods and capital, but little progress in single labour market. Main difference with US or regions within e.g. UK. Need single labour market. But movement of labour in Europe causes tensions. Completing single labour market controversial and may deter countries like UK from joining. (Published: 05/06/08)
Notes:
- ECB has maintained average eurozone inflation between 1.6 and 2.5 per cent since 2000
- growth of prices and output
- for EU as a whole: both about 15%
- but: wide discrepancy among member states
- Ireland: 31% and 44%
- Germany: 5% and 11%
- UK: 18% and 20%
- the higher a country's inflation on joining the euro, the greater has been the price level rise thereafter
- inflation convergence observed before the euro has not therefore continued since
- How much of this is due to the "one-size-fits-all" monetary policy?
- setting a single nominal interest rate for all eurozone countries implies that high inflation countries have a low - even a negative - real interest rate, while low inflation countries have a higher - and positive - real interest rate
- the lower the real interest rate, the higher is economic activity and hence inflation
- therefore, we would expect output levels and inflation rates to diverge
- But as inflation rates have not diverged either, this explanation cannot be the whole story.
- Having a more rapidly growing price level implies a loss of competitiveness.
- This, together with higher output, may be expected to raise exports from lower to higher inflation countries, thereby reducing economic activity in high-inflation countries and increasing it in low inflation countries.
- conventional view is that these effects will be strong enough to act as an automatic corrective to the divergence otherwise inherent in having a common monetary policy
- has not happened
- may have prevented inflation rates from diverging, but it has not resulted in inflation and output growth rates converging as required in a successful currency union
- not fault of ECB: remit is aggregate euro area inflation, not that in member countries
- what can be done?
- short-term and long-term solution
- short-term: countries need more flexibility in the conduct of their fiscal policy
- only macro-economic policy instrument left to stabilise their economies in the short term is fiscal policy
- control of their interest rate and their exchange rate given up
- need ability to adopt different rules from those in the stability and growth pact
- correct framework for fiscal policy is to tax-finance permanent expenditures and debt-finance temporary expenditures
- non-cyclical expenditures, such as those on health and education, should be financed through taxation, but additional cyclical expenditures, like unemployment benefits, should be debt-financed
- no matter the size of deficits in business cycle slowdowns, countries should be allowed to finance them through debt
- provided the additional debt is paid off during the good times
- long-term: raising productivity and completing the single market
- more difficult to achieve and more controversial
- Improving productivity requires using the eurozone's advantages in human capital to innovate in new products and processes.
- This must be coupled with moving out of economic activities in which competitiveness has been lost and into new activities that give a temporary monopoly that is exploitable in world markets which would result in benefits to all countries.
- single market legislation has helped produce a single market in goods and capital, but there is little or no progress in creating a single labour market
- problems brought about by a one-size-fits-all monetary policy also apply to the states of the US and the regions of the UK but, because of labour mobility, are manageable
- recent tensions brought about by recent movements of labour in Europe show that completing a single labour market would be highly controversial and might further deter the UK and other countries from joining
