by Henry Farrell on January 29, 2007

Dan Drezner looks at the “FT”: and “wonders”: why economists are debating whether the euro might become the world’s reserve currency at the same time that EU citizens say that they don’t much like it. Perhaps some of the answer lies in the different priorities of citizens and central bank economists, as described in another FT article “on the same topic”:

But the results at least offer the European Central Bank comfort on one front: expectations of inflation-beating wage rises are not widespread. Just under half of adults in employment across the countries surveyed expect to receive a pay rise this year. Of those expecting a pay rise, roughly 23 per cent expect a rise above the rate of inflation but 24 per cent expect an increase below the rate. … Fears about inflationary pressures from the labour market are a main reason why the ECB has signalled further interest rate rises are likely.

This suggests that under 11.5% of citizens in the countries surveyed expect that their pay will increase in real terms this year (this at the same time, by the way, that London City types are “writing op-eds”: telling readers how “we can all profit from million dollar City bonuses.”) Wage-inflation spirals how are ya. While the average punter may not draw the precise causal connections between (a) the institutionalized imperative for the European Central Bank to avoid inflation at all costs and (b) high interest rates and slow growth, he wouldn’t be all wrong to suspect that there’s something decidedly funny about the ECB’s priorities in setting monetary policy for the euro.

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Exchange rate
01.30.07 at 10:48 am



dearieme 01.29.07 at 12:14 pm

A letter in one of the papers today posed a good question. If the Euro is permanent, why is one of the Euro-zone governments still stockpiling notes of its former currency?


lemuel pitkin 01.29.07 at 12:40 pm

This is the debate we need to be having. After Seattle, a friend of mine said, “It’s not left and right any more, it’s top and bottom now.” Premature, what with 9/11 and Iraq, but not, I think, wrong….


Kevin Donoghue 01.29.07 at 1:13 pm

I’m not sure what’s puzzling Drezner. Perhaps he foresees a return to national currencies but at the moment that doesn’t look very likely. It seems to me that things are going pretty much as the architects of the Euro anticipated. The ECB interprets its role in much the same way as the Bundesbank did, i.e., to keep inflation down. (Economic growth? It’s not my department, etc.) If you are a non-European looking for a reserve currency that’s what you want: a reliable store of value. So, unless the ECB is forced to change, the chances are that the Euro will assume a greater reserve role.

Has the average (and/or median) punter really suffered? European labour markets mostly weren’t all that different in the days when marks, guilders, francs and lire were merrily smashing up the good old ERM.


Doug 01.29.07 at 3:39 pm

The ECB is, as noted in 3 above, the Bundesbank writ large, and this was widely understood in the national governments, national central banks and international financial markets at the time. On the other hand, almost all of the euro zone as it exists now had been following the Bundesbank de facto for a substantial period of time, so I, too, am not sure how much is different. At least now the countries all have seats on the board instead of leaving it all to the Germans.


Jack 01.29.07 at 4:10 pm

Euro-sclerosis? Are you Megan McArdle in disguise?

Is the diffference between ECB policy and any plausible alternative in the top ten reasons for increasing inequality? For supposedly slow growth?


John Quiggin 01.29.07 at 5:44 pm

It would be interesting to compare attitudes to switches to decimal currency at a similar point. I can certainly recall people complaining about it for quite a while afterwards. And decimal currency had the obvious benefit of being easier, whereas the euro only makes life easier for people who travel within the eurozone reasonably often.


Jacob Christensen 01.29.07 at 6:05 pm

I’m too lazy to download and read the 62 MB Eurobarometer report (here, if you want it), but an excerpt from the executive summary notes this

The main benefits stemming from the introduction of the euro are regarded to be cheaper and easier travel (most Europeans take euro cash with them even if they travel outside the eurozone); easier price comparisons; and a stronger position of Europe on the world stage. On the other hand, citizens almost unanimously blame the euro for increasing price levels.


Awareness of the Stability Pact is very low: many citizens report that they have not heard about it, and even the majority of those who say that they have heard about it have no clear idea about what it exactly is. Still, many people have an opinion on the Pact: it is generally seen as successful in providing stability to the euro.

The question could be if the Stability Pact – Inflation Goal – High Rates link is too complicated for the Ordinary Joe (Josef Schultz?), or if the complaints about price increases are used as a replacement in the criticism.

Declaration of interest: I voted “yes” in the Swedish referendum in 2003, but in an interview with a local newspaper I actually mentioned the no-inflation goal as a problem.


Henry 01.29.07 at 8:38 pm

Jack – while I don’t suggest in this post that there’s a link between ECB policy and inequality (the comment on the City is an aside, not a causal claim), there is a plausible argument, put forward by Colin Hay, suggesting that the Growth and Stability Pact may undermine basic social protections (by capping deficits, forcing govts to scale back public spending and run a surplus etc). I don’t think that this argument is more than plausible however, because the Growth and Stability Pact is being honoured as much in the breach as in the observance (which is to say that it may produce the effects that Hay is pointing to, but a pretty detailed examination of how the rules affect national policy in the absence of strict universal enforcement would be necessary to prove this; I’m not aware of such a study). The effects on growth are pretty clear though, through higher interest rates etc. You do suggest that the necessary comparison is “with any plausible alternative” – my response would be that the universe of ‘plausible alternatives’ is to a considerable degree an ideological artefact. See further, Mark Blyth, _passim._ And the ‘euro-sclerosis’ is a joke on the original meaning of eurosclerosis. I don’t know what Megan’s position on the ECB is, if she has one, but the _Economist_ is peachy keen on independent central banks that devote themselves solely to fighting inflation.

John, Jacob, I suspect that there is something like this going on (which is why I didn’t say that I thought the average punter had it right on the causal connections). Much of the opposition to the ‘teuero’ surely comes from the perception that it led to a once-off hike in prices. But I’m also guessing that something like Morris Fiorina’s retrospective voting model is going on here. That is, that consumers may not be aware exactly of what is happening, but they do correctly perceive that economic times aren’t what they should be, and retrospectively assign some of the blame, as it should be assigned, to the introduction of the euro.


Tom T. 01.30.07 at 12:17 am

Take a look at the full results of the FT poll in the article cited by Drezner. It finds that a majority of respondents in France, Italy, Spain, and Germany think that the euro has harmed their country’s economy, but at the same time, a plurality in Italy, Spain, and Germany (and a significant number in France) think that the euro has had a positive effect on the EU economy as a whole. So, a sizable chunk of poll respondents seem to think that the euro is benefiting all Europeans (in the EU, anyway) except themselves.

Also, according to the poll, most respondents think that immigration is depressing wages in their country, and a plurality are negative about admitting countries like Bulgaria and Romania into the EU. Basically, a lot of respondents seem to see themselves as being dragged down by others within and without the EU.


Doug 01.30.07 at 3:25 am

“my response would be that the universe of ‘plausible alternatives’ is to a considerable degree an ideological artefact”

Artifact or not, it is a view that is widely, perhaps almost universally, held in the markets that European states would have to turn to for additional credit. Pursuit of an inflationary alternative (even with a national currency) would produce high interest rates rather quickly as well as weakening the currency, probably making the proposed cure worse than the purported disease.

The interesting case would be pursuing a loose policy while remaining within the euro zone, thus attempting to free ride on the other economies. Would the ECB and the other member governments react strongly enough to protect their own interests? If one of the smaller economies tried, maybe not. (Or they might just boot it from the euro zone, irrevocability notwithstanding.) But if, say, Spain, France or Italy went down that road, it’s a much more serious case. Yet another reason, I think, that the German government fought so hard to put the ECB in Frankfurt and against French proposals of ‘political oversight’ of the bank.


Cirkux 01.30.07 at 5:16 am

I was under the impression that the strong link between wages and inflation that seems to be ruling all policy since Thatcher had been discredited, but perhaps some firendly economist can clarify?


Bob B 01.30.07 at 5:38 am

The appeal of the Euro as an alternative reserve currency to the US Dollar has at least as much to do with the current weaknesses of the Dollar (the notorious twin deficits) as the merits of starting European Monetary Union at the end of 1999.

The German economy and its people have been through much pain because the DMark entered the Euro at an overvalued exchange rate. This was because German employment costs in manufacturing (according to the US Bureau of Labor Statistics as well as other sources) were notably higher than those of other prospective Eurozone member countries in the lead up to entry. What has happened since is consistent with that diagnosis – as reported in The Economist of 25 January 2007 (subscription):

“Germany’s recent history shows how hard it is for a member of the euro club to recover from a cost-induced slump. Devaluation might have been an obvious remedy, but can only be achieved by leaving the currency union. The only other solution is to drive down wage costs relative to those in competing countries. This option is also costly: Germans have paid the price in terms of high unemployment and stunted growth. Cost reduction is also painfully slow. Workers are resistant to pay cuts, so the necessary reduction in real wages relies on a long period of below-average inflation. This kind of wage discipline has underpinned Germany’s revival.”

The painful looming adjustment problems were widely foreseen by academic economists in Germany prior to the start of the Euro as this report in the Financial Times of 9 February 1998 shows:

“More than 150 German economics professors have called for an ‘orderly postponement’ of economic and monetary union because economic conditions in Europe are ‘most unsuitable’ for the project to start.

“The call to delay Emu ‘for a couple of years’ is made in a declaration signed by 155 university professors and sent to the Financial Times and the Frankfurter Allgemeine Zeitung newspaper in Germany. It signals intensified opposition to the government’s euro policy.

“The declaration was organised by Manfred Neumann, professor of economic policy at Bonn university and chairman of the Bonn economics ministry’s council of expert advisers. It signals concern among professional economists about Bonn’s determination to begin the single currency on January 1 1999. . . ”

At least in retrospect, even Jacques Delors – President of the EU Commission at the time of negotiations for the Maastricht Treaty – agrees that there were unresolved issues at the launch of the Euro:

“JACQUES DELORS, the former President of the European Commission, fuelled the controversy over the euro yesterday by admitting that Britain was justified in opting out of the single currency because its launch was flawed.

“In a remarkably frank interview with The Times, the one-time bogeyman of Eurosceptics also predicted that Britain would stay out for years, not least because Gordon Brown was so ‘passionate about his contempt for Europe’.

“In another startling admission, the veteran French leftwinger said that the European Union was in a ‘state of latent crisis’ because of weak leadership. He blamed member state leaders, including President Chirac of France, for putting national interests before the common good. . .

“But his most surprising comments were on the euro. He lamented that EU leaders had failed to heed his warning that monetary union must be matched with close co-ordination of economic policies, and argued that the euro was consequently less attractive than it could have been.”,,740-967150,00.html

As I recall it, in the official assessments made of eligibility to join the Euro according to the criteria set out in the Maastricht Treaty, only Luxembourg qualified. Britain would have qualified too but for the fact that the Pound had not been in the Exchange Rate Mechanism for the required two years prior to the launch – famously, the Pound was taken out of the ERM in September 1992 and Britain’s economy has performed better on trend since than the other major EU economies. By the end of 1995, the standardised unemployment rate in Britain was lower than in the other major EU economies and the employment rate of working age people higher.


John Sheehy 01.30.07 at 9:15 am

A lot of casual assumptions seem to underlie the posting and some subsequent comments. Let’s start with:

“While the average punter may not draw the precise causal connections between (a) the institutionalized imperative for the European Central Bank to avoid inflation at all costs and (b) high interest rates and slow growth”

What? Between 2002 and 2006, GDP per capita grew faster or just about as fast as it did in the USA in almost half of the euro area countries. Is the USA a slow grower?

Or take Jacob’s point on whether “the Stability Pact – Inflation Goal – High Rates link is too complicated for the Ordinary Joe”. Well, it is too complicated for me. The point of the Pact, by controlling public finances, is to keep rates down. As for Henry’s contention that the Pact forces governments to run a surplus, well that’s just not true. The Treaty obliges EU Member States to avoid excessive deficits, by which is meant a deficit to GDP ratio and a debt to GDP ratio not exceeding reference values of respectively 3% and 60%.

Finally, Henry’s point “that consumers may not be aware exactly of what is happening, but they do correctly perceive that economic times aren’t what they should be, and retrospectively assign some of the blame, as it should be assigned, to the introduction of the euro”. It’s ironic that Italians don’t like the euro, because they’d be paying a lot more to service their debt and finance their mortgages if they didn’t have it.


Suvi 01.30.07 at 2:01 pm

“As I recall it, in the official assessments made of eligibility to join the Euro according to the criteria set out in the Maastricht Treaty, only Luxembourg qualified”

iirc, all of them qualified, except for Belgium on debt (which doesn’t matter, because they can’t print their own money anymore anyway) and Italy on something or other.

“In a remarkably frank interview with The Times, the one-time bogeyman of Eurosceptics also predicted that Britain would stay out for years, not least because Gordon Brown was so ‘passionate about his contempt for Europe’.”

Whatever. But he’s almost certainly apprehensive about the mayhem effect that lower €€ rates would have on the housing market (as if it wasn’t bad enough anyway). And the crash that must inevitably follow.

And he seems uncertain what it will mean for city jobs.

Can’t someone galvanise DSquared into posting?


Kevin Donoghue 01.30.07 at 2:22 pm

Can’t someone galvanise DSquared into posting?

Checking his blog, I note that a certain Professor Emeritus has done so.


Doug 01.30.07 at 3:23 pm

Bob B (at 13), I think we’ve crossed comments on this before over at Fistful of Euros, but for the potential benefit of the rest of the audience here: I was in the financial markets at the time the euro was finalized, advising people who were trading very large sums in both bonds and currencies. I remember very well the letter of the German economists. In purely economic terms, it also made a fair amount of sense. In the world that features financial markets and governments of fallible people, by the time the letter was published you could have order, or you could have delay, but you not have both. Any delay would have unwound the Italian position at the least and undone much of the confidence the markets had built up in the introduction of the euro. How many of the signees sincerely thought there could be delay and order, and how many wished to use ‘delay’ as a softer way of killing the project, I don’t know. But I do know that if the governments had instituted delay in 97/98, there would not have been a euro for many years, if ever.


Bob B 01.30.07 at 5:09 pm

Re: #14 by “exchange rate”

Try: Table 1: Indexes of hourly compensation costs in U.S. dollars for production workers in manufacturing, 33 countries or areas and selected economic groups 1975-2005

By the data there for 1998, hourly compensation costs in Germany converted to US Dollars, at the prevailing exchange rate, were higher than in any of the other 32 countries covered in the survey – which was not a propitious beginning. The issue then becomes whether productivity in German manufacturing industries was sufficiently high relative to that in trading partners to offset the disadvantage of the comparatively high German employment costs. The short answer is that in some industries/businesses (eg automotive engineering) productivity was sufficiently high in Germany to offset the disadvantage but overall there weren’t enough such businesses.

The second telling point is that the German economy accounts for about a third of the Eurozone economy. Hence, if the German economy is depressed because of its relatively high employment costs that has a depressing effect on the whole Eurozone economy.

Re: #15 by “suvi”: “all of them qualified, except for Belgium on debt”
Sorry, but I have to say that is untrue.

In the lead up to the launch of the Euro, the Financial Times kept up a running commentary on which EU were likely to meet the five Maastricht criteria (in summary):

– Budget deficits no higher than 3%
– Outstanding public debt no higher than 60% of GDP
– Inflation rate no higher than 1.5% of the average of the three best performing EU states
– Long government bond yields not more than 2% higher than the average of the three lowest
– Exchange rates must be within the normal ERM for two years before membership eligibility is decided.

On this, I’ve no online links and I’m relying on the report in: Financial Times: The Birth of the Euro (Penguin Books, 1998), chp.3.

For starters, the following EU countries did not meet the Public Debt condition at the time: Austria, Belgium, Denmark, Germany, Greece, Ireland, Italy, Netherlands, Portugal, Spain, Sweden.

And France didn’t meet the Budget Deficit condition.

Re: #17 by “Doug”: “I remember very well the letter of the German economists. In purely economic terms, it also made a fair amount of sense.”

Quite – a lot of folks were led up the garden path by politicians and Euro enthusiasts. I don’t accept the claim that there was a unique window for launching the Euro. A lot of work still needs to be done in the major Eurozone economies to improve market flexibility, work should should have been done before the launch. See the recent OECD take on the relative importance of the Euro and market flexibility:


Suvi 01.30.07 at 5:50 pm

“For starters, the following EU countries did not meet the Public Debt condition at the time: Austria, Belgium, Denmark, Germany, Greece, Ireland, Italy, Netherlands, Portugal, Spain, Sweden

That’s not what I read at the time, but so what? What difference does it make how much debt they have?

Denmark and Sweden didn’t join anyway, the laggards!


Glorious Godfrey 01.30.07 at 5:59 pm

For more pointed criticism of the ECB’s bad BuBa legacy, see here

On another note, I find that the following chain of thought is seldom followed:

Germany has increased its competitiveness in no small measure thanks to draconian restraint in wage growth. This is not only due to ECB policy. Global and European wage arbitrages (the latter reinforced by the recent EU enlargement) play a big role.

The phenomenon has been characterized by some as “competitive deflation”.

Wouldn’t this competitive deflation, in a hypothetical EU without euro, incite such countries as Italy and Spain (but also France and in all likelihood many of the new Eastern European members) to old-school competitive exchange rate devaluations? Wouldn’t both processes reinforce each other, potentially sinking Germany in a deflationary hole truly worthy of the name and causing high inflation and perhaps a financial scare or two in the devalutation-happy states? Couldn’t that put the EMS (still in place under this scenario) under enormous, even fatal strain?


Bob B 01.30.07 at 8:13 pm

“to old-school competitive exchange rate devaluations”

C’mon. Why the pejorative overtones? The British Pound’s exchange rate is determined by market forces – as are the exchange rates of the US Dollar, Japan’s Yen and the Canadian Dollar. Is all that ol’ fashioned too?

What keeps the Pound so buoyant is hardly Britain’s trade balance – which has a widening deficit – but the continuing inflow of foreign investment into Britain:

“BRITAIN was in the vanguard of the biggest global boom in foreign direct investment (FDI) for five years during 2005, attracting a lion’s share of surging direct investment inflows to rich nations, the Organisation for Economic Co-operation and Development said yesterday.

“A near-trebling in FDI inflows into the UK, fuelled by several multibillion-pound takeovers of leading companies here, meant that Britain leapfrogged the United States to become the top direct investment destination in a bumper year for the activity, the Paris-based OECD’s figures showed. . . ”,,16849-2248152,00.html

On the Eurozone, the OECD is making much sense in my view in stressing these priorities in its latest policy brief for the area:

i) reducing labour market rigidities so that economies can cope with change more easily. A key part of this is to make wages more flexible;
ii) boosting competition, especially in the protected service sector, to make inflation less sticky and take some of the pressure off monetary policy; and
iii) continuing to integrate and develop financial markets. Some countries are already a long way down the road of structural reform, and are performing well as a result. Others have some catching up to do.

But that is evidently not how leading French politicians see it in the run-up to the coming Presidential elections there:

“In December France’s Prime Minister Dominique de Villepin urged Europe’s politicians to reassert control over their national economies and to restrict the powers of the [European Central Bank]. Ségolène Royal, socialist candidate for the [French] presidential elections in May, has gone even further, accusing ECB president Jean-Claude Trichet of usurping democratic authority. ‘It’s not for Mr Trichet to dictate the future of our economies: it’s a matter for our leaders chosen by the people. We must completely change the charter of the central bank,’ she said.”

That looks remarkably like a call for going forward to the past.


Bob B 01.31.07 at 5:53 am

News update:

“The French election campaign brought the streets of London to a halt last night as Nicolas Sarkozy became the first presidential candidate to hold a rally outside France.

“Police struggled to control the crowd of hundreds of French citizens living in Britain as they attempted to see the dynamic Interior Minister, who is favourite to succeed President Chirac.

“Addressing 2,000 cheering expatriates at the old Billingsgate fish market, Mr Sarkozy spelt out his vision of a modern France no longer trapped in the past. The audience of students and business people shouted ‘Sarko!’, waved the Tricolour, and sang La Marseillaise as video screens declared: ‘Together, everything is possible.’ They then broke out into Happy Birthday — in English — in tribute to the centre-right candidate’s 52nd birthday on Sunday. . .

“However, the London election campaign is not without risk. Dominique Réynie, a political analyst, said: ‘France hasn’t suddenly renounced its ancient enmity with England, and it is still the “little America” in Europe. So it could reactivate the accusation of ‘Sarkozy the Anglo-Saxon’.”,,2-2575574,00.html


Suvi 01.31.07 at 1:25 pm

“On this, I’ve no online links”

Why not, bob?

Isn’t it true, or is it too silly still to assert? (Not your fault, but FT’s)


Bob B 01.31.07 at 4:56 pm

There are many nowadays with powerful motives for being less than transparent about which countries in the Eurozone didn’t meet the Maastricht eligibilty criteria at the launch of the Euro in 1999, which perhaps helps to explain my difficulty in finding online links.

The valuable Financial Times compilation of commentary by its journalists: The Birth of the Euro (Penguin, 1998) is out of print now but available in used copies via amazon. Very likely there are academic papers which cover the subject but (sadly) I don’t have access via JSTOR and the like to hunt around scholarly archives.

An interesting wider issue is whether out-of-print books should default to the public domain.


Bob B 01.31.07 at 5:18 pm

Btw how’s this for a quote on the motivation for installing European Monetary Union?

“In 1996, Phillippe Maystadt, then the Belgian Finance Minister and now president of the European Investment Bank, said that: ‘The purpose of the single currency is to prevent the encroachment of Anglo-Saxon values in Europe.'”

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