A spanner in the works

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EMUs prospects

IN HIS speech announcing his country’s surrender in 1945, Emperor Hirohito referred to the atomic bombs that had destroyed Hiroshima and Nagasaki as developments “not necessarily to Japan’s advantage”. When it comes to monetary union, Europe’s leaders may likewise be beginning to suspect that recent events have not necessarily been helpful.

France, tired of the stringent budgets and high unemployment that preparing for EMU is said to entail, has sacked its government. The newcomers, Lionel Jospin’s Socialists, are pledged to soften the Maastricht treaty’s criteria for participation in the single currency—conditions hitherto deemed vital to ensure that the euro would be sound. Meanwhile Germany’s government, itself struggling with its failure to comply with the Maastricht rules, tried to ease its way by bringing forward a revaluation of the country’s gold reserves—that is, by cooking the books like any normal European government. After vigorous protests from the independent central bank, Chancellor Kohl backed down. So in Germany, as in France, reconciling the present design for monetary union with political and financial reality has become impossible.

Surrendering to the truth

The French were voting more against the policies of the right—see the next article—than against the idea of EMU. The subject was hardly raised during the campaign; the project has been championed by the Socialists (notably by Jacques Delors); and Mr Jospin has said he will take France into the single currency on time. Implicitly, though, France has voted against the Maastricht design. Whatever else they said or did not say, the French cried no to budget stringency of the sort the Maastricht plan demands. If EMU is to go ahead, the treaty’s budget rule will have to be abandoned; or, as one French Socialist put it this week, “developed”.

Will an altered—meaning softened—EMU be politically feasible? There will be difficulties in pressing on regardless, to put it mildly. But Germany is the key, and its government still wants EMU at almost any price. Yes, the Bundesbank is sceptical and the German electorate, to the extent that it has formed a view, is deeply reluctant to see the D-mark disappear. Yes, a softening of the Maastricht rules could let Italy, Spain and almost anybody else into the first round. Yes, there will be an election in Germany before EMU can happen: Germany’s voters could pull the plug at the last moment. But “determined” is too small a word for Mr Kohl, and the alternatives to pressing on—postponement or outright cancellation—offer instant humiliation for most of Europe’s leaders. On balance, expect EMU to happen (see

A different question is whether a monetary union created under these farcical circumstances can be anything other than a disaster. On the view that the budget criterion served a crucial purpose, the outlook is bleak. Excessive deficits would cripple the new system at the outset, undermining the ability of the new central bank to curb inflation. If the euro does take flight, it will be the lira writ large, not the D-mark. Financial markets seem to be adopting this position: Europe’s main currencies all slid against the dollar this week, apparently forecasting an EMU that happens but then goes wobbly.

Given time to reflect, the markets may come to a different and better-founded view. The deficit criterion was misconceived from the start. Certainly governments should balance their budgets over the course of the economic cycle. But there is no virtue in cutting the budget deficit to less than 3% of GDP, as the Maastricht plan requires, at a time when unemployment is 13% of the labour force, as it is in France. Zeal like that gives fiscal conservatism a bad name. The best kind of monetary union would leave countries far more flexibility in the use of fiscal policy than the Maastricht design and its supplementary “stability pact” allow. The burden of ensuring that the euro is strong and stable is better placed elsewhere: with a truly independent central bank and with the popular support it will need to command.

Precisely because so much effort has been squandered on complying with the Maastricht treaty’s misguided fiscal targets the euro seems likely to fail the tests that matter. The new French government says that it may want to modify the responsibilities of the new central bank, requiring it to pay more attention to employment and less to inflation. So a danger over the coming months is that the new bank will take on a political character that impairs its effectiveness.

As for the importance of popular backing, only consider how the Bundesbank defeated politicians’ efforts to implicate it in their accounting fiddles. How many central banks could have acted so firmly? What made it possible was the regard which German citizens have for the institution. Europe’s governments have failed to build support for EMU. Throughout, they have regarded the plan as a matter for the elite, too complicated to be explained, let alone referred for decision, to mere voters. Now the problem is not just lack of effort to build support for this dramatic constitutional innovation, but the fact that the transition to EMU discredits the whole idea. The Maastricht process has come to stand not for the great opportunity that the single currency might have been, but for ineptitude, dishonesty and stagnation. When the new system is tested, as it will be, this weak foundation will be exposed.

This may not guarantee failure, but it undoubtedly makes the future riskier than it need have been. If things go wrong, events may then unfold in a quite different way from the one the markets seem to expect. The people appointed to the new central bank will be conscious of the need to establish their credibility. To do this, given the circumstances attending the euro’s birth, they will have to be firmer on interest rates and inflation than would otherwise have been necessary. Governments may then feel obliged either to challenge that stance, or to offset it with fiscal relaxation. A mixture of over-loose fiscal policy and needlessly tight monetary policy could ensue, driving the euro up not down (like the dollar under Reaganomics in the early 1980s). That would bash exporters and jobs in manufacturing. And it would bring the new central bank to an early, and possibly terminal, political crunch.

When Europe’s leaders meet in Amsterdam on June 16th and 17th, monetary union, as tradition requires, will not be on their agenda. They really should squeeze in a few moments on the subject. It is too late to undo the harm that the Maastricht design has already done to the cause of monetary union, but it is not too late to stop the rot. Abolish or radically recast the fiscal-policy rules; affirm rather than qualify the independence of the proposed central bank; above all, engage the public and let popular opinion have the final say. Otherwise, watch out for more falling governments.

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