CAMBRIDGE – The economic recovery that the euro zone anticipates in 2010 could bring with it new tensions. Indeed, in the extreme, some countries could find themselves considering whether to leave the single currency altogether.
Although the euro simplifies trade, it creates significant problems for monetary policy. Even before it was born, some economists (such as myself) asked whether a single currency would be desirable for such a heterogeneous group of countries. A single currency means a single monetary policy and a single interest rate, even if economic conditions – particularly cyclical conditions – differ substantially among the member countries of the European Economic and Monetary Union (EMU).
A single currency also means a common exchange rate relative to other currencies, which, for any country within the euro zone, precludes a natural market response to a chronic trade deficit. If that country had its own currency, the exchange rate would decline, benefiting exports and impeding imports. Without its own currency, the only cure for a chronic trade deficit is real wage reductions or relative productivity increases.
The European Central Bank is now pursuing a very easy monetary policy. But, as the overall economy of the euro zone improves, the ECB will start to reduce liquidity and raise the short-term interest rate, which will be more appropriate for some countries than for others. Those countries whose economies remain relatively weak oppose tighter monetary policy.