Fundamental Macroeconomic Flaws in the Euro

Mark Xenakis

International Accounting

Fundamental Macroeconomic Flaws in the Euro

Five years ago, the biggest thing in economic and international news was the introduction of the new European currency, the Euro, into circulation and into the pockets of the consumers of the participating countries within the European Monetary Union. In an attempt to unite Europe and to form a dominant currency to rival the US dollar, Europe locked their exchange rates and went full steam with this plan. Unfortunately, for many of the European countries, what seemed to be the end all for European economics, quickly unraveled the inherent reality of the fundamental macroeconomic flaws in the European monetary system that may cause its downfall and deficit policy that could lead to its utter collapse. Even with this in mind, some speculate that, with the right amount of revision and monitoring, the Euro might actually have a chance of becoming the worlds leading currency. In any cases, however, before looking this far into the future, we must first remember the past.

For decades, Europe and all of the countries within its continental borders have disagreed, argued, and on many occasions, fought wars over disputing issues, differing cultures, and the occasional expansionist fascist. From WWII, to the Russian uprising, Europe has been separated by years of wars and hatred. And despite attempts, it is this reason, among many, which has hindered the coming together and agreeing upon many common goals needed for Europe to grow and thrive as an economic contender.

Since these post war years, Europe has seen many steps taken to unify Europe. We have seen the formation of the European Union which has been a crucial step and huge driving force in the thought process behind the Euro itself and many more pieces of legislation and plans for future European monetary policy.

"One of the unique characteristics of Europe that make it different from any other region in the world is the extreme political fragmentation that has existed and the diversity of its population. People that travel Europe can be amazed by the fact that every few hours they can enter into a new country with a different language and culture". (Soto)

Despite these differences, the European Union came together in the 1970's to adopt two plans that would ultimately alter the monetary face of Europe as we know it--the Warner plan and the subsequent proposal statement on the prospects of a monetary union (EMS). These were said by many to be two of the most important and ambitious plans proposed and passed by the EU.

"It [Warren plan] stressed the need to move forward simultaneously in coordinating policy, and in narrowing exchange rate margins, the integration of capital markets and the establishment of a common currency and a single central bank"(Urwin )

Even though this movement was so ahead of it's time, it created the vision of a united Europe and set the foundation for other EU developments toward European integration. The EMS was not as ambitious or as idealistic as the previous warren plan was, but rather it was more of a realistic set plan that laid out how to go about the long road toward integration. The EU moved closer and closer throughout the 1980's and the 1990's as many more agreements and treaties were introduced and signed.

Finally, five decades after the end of the WWII, Europe was in the final stage of essentially accomplishing the "unacomplishalble". On January 1, 1999 the European Union and its 11 pioneering nations composed of Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, The Netherlands, Portugal, and Spain accepted the Euro as their new currency.

There is no doubt that the major players within the European Union had good intentions and brilliant, idealistic, plans for the Euro and for the uniting of Europe. The Euro was not just thrown together in a day, it has been worked on since the 70's and to say it was poorly thought out wouldn't really fit the bill. The Euro does have many underlying benefits but as the saying goes, there is no such thing as a free lunch. Currently standing at $0.78, the value of the Euro is a far cry from its $1.17 introduction in 1999. Obviously its benefits don't come without its costs, and as I will make clear in these next paragraphs, the Euro has enough problems to go around.(Soto)

Theoretically, there two basic requirements for a monetary Union to succeed; There should be an optimal currency area, and there must be a convergence of the economies of the participating countries.

Krugman and Obsfel define an optimal currency area as "groups or regions with economies closely linked by trade in goods and services and by factor mobility".(1994) If the conditions to the OCA are met, the area involved will theoretically benefit from the fixed exchange rate system as proposed by the Euro. And likewise, if Europe did not constitute an OCA, the costs to the Monetary Union would exceed the benefits from it. So the obvious question then becomes-Is the Euro zone an OCA? Lars Jonung, from the Stockholm School of Economics don't think so:

"Europe is not an optimal currency area--that is , a geographic area well suited to have only one currency. There is no common currency cycle, at least not yet."(Soto)

Martin Feldstein of Econ Log explains why Europe is not an optimum currency area, even though the United States is one.

"First , American employees move within the country when demand is relatively weak in a particular region, facilitated by a common language and culture that regaurds moving across the country as perfectly normal. Germans are not leaving Germany in large numbers for areas of Europe with faster growth or lower Unemployment. Second, wages are much more flexible in the US than in Europe, reducing the decline in regional employment that occurs when demand falls. And third, the US has a federal fiscal system that directly offsets about 40 percent of the relative decline in any state's gross domestic product by a lower outflow of taxes to Washington and a higher inflow of transfer payments. European fiscal systems are still largely national."(Feldstien)

One of the most important characteristics that differentiate The European Union from US is the Labor market. In the US, companies have almost no cost for labor except the obvious payroll and finding a qualified, skilled person to fit the position. US companies can also adjust their profits modifying their payrolls. People can easily go from one side of the country and have no problem