COLUMNISTS The long-term viability of the eurozone has become a hotly debated topic. The blogs are full of it. The latest contribution comes from the London-based Centre for European Reform in the form of a pamphlet entitled: Will the Eurozone Crack?
My own prediction: it is the critics who will crack first.
There are two questions to distinguish. The first is whether it is conceivable that one or more member countries could leave the eurozone without destroying the monetary union. The answer is yes, it is conceivable, but I would not bet my life savings on it. The second question is whether monetary union itself could collapse and member states revert to national currencies. My answer to that question is unequivocal: no, forget it.
Most hypothetical exit scenarios involve Italy, which has suffered from a large and persistent loss of competitiveness, as measured by the real exchange rate. So what would happen if Italy left or was forced out? Do not believe anyone who claims to know the answer. There is no script for such an event. In particular, it is not clear whether a country that left the eurozone would also have to leave the European Union.
I would expect members of the eurozone to have a different view on this subject from non-members. There are no prescribed proceedings in European law for this hypothetical situation. The uncertainty about a quitter’s future status alone may provide sufficient incentive not to leave. But if a country decided to pull out after all, I would expect the EU to be more at risk of cracking up than the eurozone itself.
This brings us to the second question. What are the circumstances under which the eurozone could disintegrate? In practice, that would happen only if either Germany or France decided to quit. A departure by Italy or Spain, or both, would not suffice. However, it is extremely difficult to construct even a purely theoretical scenario under which it would make sense for France or Germany to reintroduce national currencies. A decision to quit would never pay off for the quitter in the short run. The administrative costs would be crippling, financial markets would be in turmoil and the quitter would almost certainly have to pay higher risk premiums on its bonds.
In the long run, a decision to quit would pay off only in one outlandishly hypothetical scenario. Europe’s central bankers would have to develop a previously unknown tolerance of high inflation. In that case, countries with a traditionally low inflation rate might be better off leaving. They might still not do so even under those circumstances, deciding to remain members of the eurozone for political reasons. I would challenge anyone to come up with another scenario under which France or Germany would have a rational economic reason to quit. Even if they suffered an economic depression, or were about to default on their national debt, it is far from clear that leaving the eurozone would help.
The hypothetical scenario is, of course, unrealistic. The Maastricht treaty obliges the European Central Bank to pursue price stability and the ECB is more likely to overfulfil its treaty target than to ignore it. As long as this is the case, there is not the slightest danger of a break-up of the eurozone.
On the contrary, I expect the eurozone to be exceptionally stable in the long run. My optimism is supported by current macroeconomic trends. As Joachim Fels of Morgan Stanley argued on this page last week, the world is entering a phase in which we can no longer take low inflation for granted. In a world with even moderately stronger inflationary pressures, central banks matter more than during periods of near-perfect price stability. In the 1990s it was almost sufficient for central banks to pre-announce an inflation target to steer people’s inflationary expectations. This is not now the case. In an environment of rising global inflation, some central banks will be more successful than others. Of the big central banks I would trust the ECB more than most to deliver this goal. In such an environment I would expect the euro to become increasingly important as a global reserve currency and as a medium of exchange in global transactions.
Whether the eurozone turns into a successful economy with high rates of growth and employment is an entirely different matter. That will depend on the quality of economic policies in member states, the eurozone and the EU. There is a reasonable chance that the eurozone will do better in the next eight years than in the previous eight, both in absolute terms and relative to the US and the UK. Certainly, that is a contestable proposition. But make no mistake, the eurozone is here to stay.
