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The Euro: Path to a New Europe or More of the ‘Old Club'?

July 28, 2003 // 12:00pm1:30pm

Andrew Tyrie was skeptical about the very long-term future of the euro but did not see it collapsing in the near future. He did not see any immediate problems that would mark the euro's demise and thought that the euro would survive the current period of slow European growth and the threat of recession and deflation in Germany. While Germany would be tempted to return to the independence offered by the Bundesbank (the German equivalent of the Federal Reserve System) and the Deutsche mark, he felt they were still too committed to the project of an integrated Europe to abandon the euro.

Unlike the United States, the European Union does not have a single
fiscal policy and provides relatively little support to specific regions in response to a recession. Tyrie did not, however, think that the lack of a coordinated fiscal policy would itself be fatal.

In Tyrie's view, the Euro's problem lay in the origin of the euro as a political rather than an economic project. The French had become tired of having their economic policy dictated by the German Bundesbank. The Germans agreed to the euro out of memories of the Second World War and a determination to be seen to be European as well as German. Some of its creators saw the common currency as one more step to a single country. He noted, however, that the latest version of the European constitution did not mean the creation of a federal Europe but a Europe of confederated states since it also includes an exit clause that allows for formal secession.

The entry of much of Eastern Europe into the European Union would fundamentally change the balance of power within the EU. New members that adopt the euro are likely to experience inflation as they close the income and technology gap and catch up with Western Europe. With inflation expected to be higher than in existing members of the European union, new entrants may find their goods and services gradually loosing price competitiveness. Unless entry terms allow for some subsequent price adjustment, they may be tempted to leave the eurozone as well.

At the next serious economic shock Tyrie foresaw the possibility that one or more members could decide to leave the euro bloc. In the question and answer period, Tyrie noted that he understood that both the UK Treasury and the German Bundesbank had studied the process of leaving the eurozone.

Tyrie did see the need for near-term reform of the European Central Bank. At present, the bank had too little accountability to the member governments. Their proceedings were too opaque and they did not publish a full set of minutes from various meetings. Tyrie did not think the ECB should send representatives rushing around Europe from one ministry to the next but did see a tremendous need for more regular communication with the member governments and parliaments.

Will Britain adopt the euro? Gordon Brown, the current Minister of the Exchequer, and Prime Minister Tony Blair have agreed on five economic tests that must be met before joining the eurozone. In Tyrie's view, the test of cyclical convergence between the UK and eurozone economies was valid while the other four of the five tests were largely spurious. Nor did he see either party wanting to move toward the eurozone. In the Labor Party, the rivalry between Brown (who hopes to become prime minister) and Blair made any movement toward the eurozone problematic. In the Conservative Party, much of the current leadership had once fought Britain's entry into Europe and was unlikely ever to favor eurozone membership. Popular opinion in Britain was still influenced by the heritage of Keynesian economics, which emphasized the ability of national governments to achieve full employment and economic stability. Tyrie likened the current British approach to joining the euro to a family viewing a large Ming vase. Gazed at thoughtfully by members of the family, the vase is viewed as too valuable and too risky to move in one direction or another.

In terms of broader international economic policy, Tyrie viewed the need to unravel the major imbalances in the U.S. economy as the principal challenge for the world. Tyrie pointed to several challenges for the U.S. economy: a current account deficit that may approach 6% of GDP in 2003, high external debt, large and growing fiscal deficits, and heavy levels of personal and corporate debt. The world and United States need to find a path to better balance without triggering a global recession.

With regard to exchange rates, Tyrie favored some accommodation among the three major currencies (the dollar, the euro, and the yen) to help avoid swings in value that distorted trade and investment flows and made private sector planning more difficult.

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