EMU: Risky But Worth It

STOCKHOLM: Europe is now preparing for a new currency - the euro. Advocates of EMU argue that adoption of a single currency will have many positive effects, both at the micro and the macro level. At the “micro” level, the transaction costs and uncertainties imposed on all businesses by the daily exchange of one currency for another are supposed to decrease, delivering large gains in efficiency as a result. At the “macro” level, the main effect is assumed to be lower interest rates, with positive effects on European investment and economic growth.

Although these positive effects might be substantial, few professional economists see them as sufficient to motivate the abolition of today’s exchange rate system. Most economists point out that Europe is not an optimal currency area. This is mainly because the region’s labor market is too rigid and thus unable to handle external shocks. The European labor force is extremely immobile and continental labor unions are very conservative. If, for example, one region or country in a future European currency area is badly affected by, say, a relative fall in the prices of their exports, and workers refuse to either move to where there are jobs, or adjust their salaries (downward) to the new situation, a rise in unemployment is unavoidable.

Thus, as it stands today, EMU could be compared to a pressure cooker without any relief valve built in. There are, no doubt, substantial risks of increased unemployment in the backwash of monetary unification, particularly when you factor in the already high unemployment levels in most European countries. So, given the weakness of many governments, the probability that the whole EMU project will collapse is very great.

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