A Weaker Euro for a Stronger Europe

There are few if any panaceas in economics. But a sharp decline in the euro’s exchange rate – say, by 15% – would remedy many of the eurozone’s current economic problems, including slow growth, high unemployment, and a growing risk of deflation.

CAMBRIDGE – Despite the recent upturn in some of its member countries, the eurozone’s economy remains in the doldrums, with the overall rate of annual GDP growth this year likely to be only slightly higher than 1%. Even Germany’s growth rate is below 2%, while GDP is still declining in France, Italy, and Spain. And this slow rate of growth has kept the eurozone’s total unemployment rate at a painfully high 12%.

Slow growth and high unemployment are not the eurozone’s only problems. The annual inflation rate, at just 0.5%, is now so close to zero that even a minor shock could push it into negative territory and trigger a downward price spiral. Deflation would weaken aggregate demand by raising the real (inflation-adjusted) value of household and corporate debt, and by increasing real interest rates. Lower demand could, in turn, cause the fall in prices to accelerate, sending prices into a dangerous tailspin.

There are few if any panaceas in economics. But a sharp decline in the euro’s exchange rate – say, by 15% – would remedy many of the eurozone’s current economic problems. A weaker euro would raise the cost of imports and the potential prices of exports, thus pushing up the eurozone’s overall inflation rate. Devaluation would also boost average eurozone GDP growth by stimulating exports and encouraging Europeans to substitute domestically produced goods and services for imported items. Although competitiveness within the eurozone would be unaffected, a weaker euro would significantly improve the external balance with the rest of the world, which accounts for about half of eurozone trade.

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