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THE EURO: ONLY FOR THE AGILE – Summary

Core Content

The document "The Euro: Only for the Agile" by Alan Ahearne and Jean Pisani-Ferry discusses the future of the European single currency, emphasizing that the main challenge is not about who will leave the euro area, but who will join. It highlights the importance of structural convergence and economic flexibility for countries seeking to join the Economic and Monetary Union (EMU), and the potential costs and benefits associated with membership.

Main Viewpoints

• The Euro Area is Expanding: By the end of the decade, the euro area may expand from 12 to 19 members, with three new EU member states aiming to join EMU within the next year.
• Benefits of EMU Membership: Membership in the euro area offers advantages such as a monetary anchor, lower interest rates, reduced exchange rate speculation, and lower transaction costs.
• Divergences Within the Euro Area: There are significant differences in economic performance, inflation, and real exchange rates among euro area members. These divergences are not temporary but reflect structural differences.
• Competitiveness and Real Exchange Rates: Countries with strong domestic demand and above-average inflation, such as Ireland and Portugal, have experienced real exchange rate appreciation, which has had different impacts on their export performance.
• Structural Convergence and Asymmetric Shocks: Structural convergence is essential for sustainable participation in EMU. Countries must be prepared to adjust to asymmetric shocks and maintain internal flexibility in wages and prices.

Key Information

1. Performance Measures

• GDP Growth: Since 1999, Ireland, Greece, and Spain have grown faster than the euro area average, while Germany, Italy, and Portugal have underperformed.
• Inflation and Competitiveness: Countries with strong domestic demand have higher inflation rates. Ireland has maintained competitiveness through productivity gains, whereas Portugal has suffered due to inflation and weak export performance.
• Current Account Balances: Portugal and Spain have large current account deficits, while Germany and other higher-income countries have surpluses. This reflects real exchange rate movements and structural issues.
• "China Shock": Italy and Portugal have been hit hard by competition from low-cost producers, especially China, due to their industrial structures and lack of structural transformation.

2. Problem Countries

• Portugal and Italy: These countries have faced significant economic challenges due to inflation, weak competitiveness, and low export growth. Structural adjustment is necessary to address these issues.
• Germany: Germany has experienced below-average inflation due to weak domestic demand, leading to higher real interest rates and increased competitiveness in exports.

3. Policy Implications for Current Members

• National Policies: Countries facing economic problems need to implement structural reforms, including wage moderation, increased competition, and fiscal discipline.
• Monetary Policy Spillovers: Low inflation in one country can pull down average euro area inflation, leading to more expansionary monetary policy and greater divergence.
• Enhanced Surveillance: The European Commission and Eurogroup should strengthen monitoring of economic performance and policies, using tools like the "right of alert" to identify problem countries.
• Avoid Inconsistent Goals: The euro area must avoid situations where member states pursue conflicting economic goals, such as Germany's real exchange rate appreciation conflicting with the need for other countries to restore competitiveness.

4. Policy Implications for New EMU Applicants

• Enlargement Challenges: New EU member states may face larger asymmetric shocks and require more sophisticated entry criteria than the Maastricht criteria.
• Real Convergence: While trade and FDI integration have progressed, output per capita and sectoral structures in new member states remain below EU-15 levels. Real exchange rate adjustments may be necessary for sustained competitiveness.
• Role of Fiscal and Monetary Policies: EMU entry should not be based solely on nominal criteria. Instead, it should consider the country's ability to adjust to economic shocks and maintain structural convergence.
• Need for Prudent Policies: Convergence to EMU is not a smooth process. It requires both macroeconomic prudence and microeconomic reforms to facilitate real integration and reduce asymmetric shocks.

Conclusion

The document argues that the euro area is not a "one-size-fits-all" solution. It calls for a more refined approach to EMU enlargement, emphasizing the importance of structural convergence, internal flexibility, and enhanced surveillance. The euro is only sustainable for countries that are agile and capable of managing economic shocks and maintaining competitiveness within the single currency area.