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The Euro: Monetary Unity to Political Disunity?

To commemorate its founding 25 years ago, PS will be republishing over the coming months a selection of commentaries written since 1994. In the following commentary, published two years before the introduction of the euro in 1999, the Nobel laureate economist Milton Friedman offered a concise but comprehensive explanation of why the European Union would be ill-suited for a single currency. Though the currency has survived, many of his warnings proved prescient.

SAN FRANCISCO – A common currency is an excellent monetary arrangement under some circumstances, a poor monetary arrangement under others. Whether it is good or bad depends primarily on the adjustment mechanisms that are available to absorb the economic shocks and dislocations that impinge on the various entities that are considering a common currency. Flexible exchange rates are a powerful adjustment mechanism for managing shocks that affect the entities differently. It is worth dispensing with this mechanism to gain the advantage of lower transaction costs and external discipline only if there are adequate alternative adjustment mechanisms.

The United States is an example of a situation that is favorable to a common currency. Though composed of 50 states, its residents overwhelmingly speak the same language, listen to the same television programs, see the same movies, and can and do move freely from one part of the country to another. Moreover, goods and capital move freely from state to state; wages and prices are moderately flexible; and the national government raises in taxes and spends roughly twice as much as state and local governments. Fiscal policies differ from state to state, but the differences are minor compared to the common national policy.

Unexpected shocks may well affect one part of the US more than others, as the Middle East oil embargo did in the 1970s. That event increased the demand for labor and created boom conditions in some states, such as Texas, but led to unemployment and depressed conditions in others, such as the oil-importing states of the industrial Midwest. The different short-run effects were soon mediated by movements of people and goods, financial flows from the national to the state and local governments, and wage and price adjustments.

25 years of the World's Opinion Page

Project Syndicate celebrates its 25th anniversary with PS 25, a collection of our hardest-hitting commentaries so far.

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Project Syndicate celebrates its 25th anniversary with PS 25, a collection of our hardest-hitting commentaries so far.

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