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Optimizing the Eurozone

TOKYO – The eurozone is facing a bleak economic outlook, with growth remaining stagnant and the threat of deflation looming large. The economist Martin Feldstein, who was skeptical of the initiative from the start, now calls it a “failure.” Is Feldstein right, or could the eurozone become the “optimal currency area” that its creators believed it to be?

Answering this question requires, first and foremost, an understanding of the costs and benefits of various exchange-rate systems. The International Monetary Fund was established 70 years ago to manage an “adjustable peg” system – a hybrid system in which exchange rates were usually fixed to the US dollar, but could be adjusted occasionally to improve the country’s competitive position in export markets.

For the first few decades, this system leaned heavily toward “peg,” owing to the US dollar’s direct convertibility to gold. This brought significant stability to the global monetary order, following the competitive devaluations of the 1930s that some economists considered damaging.

But the fixed exchange-rate system also undermined the United States’ capacity to manage its balance of payments. That is why, in 1971, President Richard Nixon unilaterally abandoned the dollar’s convertibility to gold, leaving major currencies’ exchange rates to float against one another.