Europe’s anchor of stability
By Otmar Issing
FRANKFURT: At less than ten years old, the euro is by all measures a young currency. Yet it has become a reality of daily life for almost 320 million people in 15 European countries. In the wake of the euro’s performance during this year’s global financial crisis, even its strongest critics cannot deny that the euro is an astounding success.
This past summer, millions of travelers avoided paying cumbersome and expensive charges to change their currency. But the advantage for trade and investment implied by the absence of foreign-exchange risks within the euro area is of greater economic importance. The common currency completes the single market for the euro area’s member states.
Since 1999, members of the European Monetary Union (EMU) have experienced a number of severe exogenous shocks: the rise in the price of a barrel of oil from around $10 to $150; the collapse of equity markets after the dot-com bubble imploded; the spreading risk of terrorism after the September 11, 2001, and two wars. Starting last summer, the breakdown of the market for US sub-prime mortgages triggered turbulence in financial markets, with no end in sight.
From past experience with national currencies, Europeans could have expected that any of these shocks would trigger a severe crisis in foreign-exchange markets. It is not difficult to imagine what would have happened during the recent financial-market crisis if the euro-area countries still had all their national currencies: immense speculation against some currencies, heavy interventions by central banks, and finally a collapse of the parity system.
The years 1992-1993 witnessed a dramatic crisis in the European Exchange Rate System. Since that period the amount of capital ready to exploit any opportunity in foreign exchange markets has multiplied, which would make any comparable situation today much more dangerous. Indeed, the crisis of the early 1990’s put the status quo within the EU common market at risk. It is hard to believe that, with today’s vast capital flows, the single market would have survived a series of sharp and abrupt exchange-rate changes.
Changes in exchange rates of the type seen in 1991-1992 have a strong impact on relative prices for goods traded between different countries. In countries that experienced strong currency appreciation, companies (and unions, for that matter) are exposed to a sudden and severe loss in competitiveness. Such firms undoubtedly start to clamor for protection against supposedly “unfair” conditions.
True, the euro did not prevent risky investment decisions by European financial institutions or the consequences for financial markets of these decisions. But it was never intended to do that. Instead, the euro achieved what it was meant to achieve: the crisis was contained, because it could not inflict damage on foreign-exchange markets within the euro area.
After the outbreak of turbulence in financial markets last year, the European Central Bank immediately provided ample liquidity to calm the situation, and has continued to do so ever since. At the same time, the ECB never lost sight of its main goal – maintaining price stability.
Indeed, the ECB has successfully anchored inflation expectations right from the start at a level consistent with its definition of price stability. This achievement contrasts starkly with all the critical voices that warned against the experiment of European Monetary Union and even predicted its early failure.
It was in the first weeks after the establishment of the ECB in June 1998 that I received a letter by the late Nobel Prize laureate Milton Friedman, who congratulated me on my appointment as member of the Executive Board – which he called “an impossible job.” He was convinced that monetary union in Europe was doomed to fail. Today, however, it is hard to find anybody who does not consider the euro a great success, and the ECB has been so sure-footed that people now take that success for granted.
But this was not a matter of good luck. The fundamentals of the euro’s success are hard work, dedicated commitment to the common currency’s unique historical mission, and, not least, a well chosen monetary policy strategy.
But this success is no reason for complacency. Major challenges lie ahead. In the context of weakening growth, the Stability and Growth Pact will face a severe new test. And, just as important, reforms aimed at ensuring greater flexibility of markets still lag behind what is needed to exploit fully the advantages of the single monetary policy.
Otmar Issing, a founding member of the ECB board and the bank’s first chief economist, is the author of The Birth of the Euro, just published by Cambridge University Press