EMU and the Credit Crunch: Can the Euro Survive?
March 20, 2009
When the euro entered circulation in January 2002, it marked the culmination of several decades’ work to forge a European Economic and Monetary Union (EMU). It was a brave move: few, if any, examples can be found of monetary unions that have successfully endured without political union. Moreover, economic convergence between many of the countries was incomplete. Today, the severity of the economic downturn poses the most serious challenge that EMU has yet faced. Can Europe’s single currency ride out the storm, or could a member state be forced to leave EMU or default on its euro-denominated debt?
Much has changed since the heady days of the euro changeover, when 12 countries—Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain—abandoned their national denominations in favor of the new single currency.
Today, the fault lines in the euro area are plain to see. It has become clear that EMU included too many divergent countries at its outset. Since January 1999, when nominal exchange rates between euro-area members were irrevocably fixed, excessive unit labor cost growth in some countries has led to large rises in their real exchange rates, crushed their competitive positions and created significant currency misalignment within the euro area as a whole. Some members have also experienced massive housing booms that are starting to unwind. Finally, there has been an inadequate degree of fiscal integration to help offset regional growth disparities. While these problems were masked during the boom years, many countries are now suffering disproportionately.
Such regional disparities raise questions about the long-term future of EMU. Key among these is the issue of whether individual governments are sufficiently committed to the single currency to overcome the domestic political tensions that are building as the economic downturn intensifies.
Currency Misalignment Is Just One Issue Facing the Euro Area