Europe, Japan and the Ghost of John Maynard Keynes

NEW HAVEN: Eleven countries within the EU are poised to merge their currencies forever into the euro. As that day approaches, are member governments changing their ideas about what discipline will determine the euro’s value?

There are advantages, political and economic, in a broad currency union, as demonstrated by the history of the US dollar. Whether these benefits can be artificially manufactured in a short period of time among diverse governments and economies remains an open question. Because there is a growing fear among governments that such benefits will occur only in the future, the commitment to fiscal restraint that marked the run up to the euro’s birth is softening as leaders seek to reconcile the single currency with the urgent need to promote growth and employment.

The members of European Monetary Union are surrendering monetary sovereignty, voluntarily to be sure, but they are surrendering it all the same. Member countries will no longer have their individual monetary policies, or even discretionary fiscal policies for that matter. They will no longer be able to adjust to payments imbalances and their macroeconomic consequences by exchange rate movements - as, for example, the U.K. did very successfully in 1992.

Economists who advocate the euro argue that anything which exchange rate adjustments can do can also be done by movements of commodity prices and wages. The evidence, however, is that these "remedies" work only very slowly and imperfectly. In the meantime, a strong euro will require high interest rates to stay high, and the cost in jobs, exports, and growth of GDP will necessarily be high as well.