The Euro: Should the U.S. Worry?

4 Colum. J. Eur. L. 447 (1998)

Elke Thiel. Senior Research Associate at the Stiftung Wissenschaft und Politik, Research Institute for International Affairs, in Ebenhausen (near Munich) and Professor for European Politics, University of Bamberg.

Should the United States worry about the euro? My answer is that it probably should not, but I add some caveats. Once established, the European Economic and Monetary Union (EMU) will affect the transatlantic relationship in various ways. Using a single currency will have advantages for the EU financial market. The euro will give the European Union more clout in the global monetary system and will put the EU on a more equal footing with the U.S. in a number of respects. Thus, the euro will alter traditional patterns of cooperation and competition in the transatlantic partnership. This need not be detrimental to the United States, but the U.S. will have to adapt to the change.

I will address the issue of change from a medium-term perspective, focusing on the structural impact of the EMU. However, because the euro has not yet been implemented, we can analyze the issues only by making assumptions about the way the EMU will ultimately function.

  1. Uncertainties Surrounding the Transition to EMU

The EMU is scheduled to begin January 1, 1999, and at present delay seems unlikely. However, it has yet to be determined which countries will qualify to adopt the euro at its inception. Until quite recently, the EMU was expected to evolve around a few core countries which have proven their ability to adhere to stable macroeconomic policies, because they would reduce the stability risks of the EMU. Yet, the current convergence figures do not identify a core which meets the stringent criteria. Instead, markets have come to anticipate a large EMU of ten to twelve Member States.

If it is solidly implemented, a large EMU will enhance the advantages of a single currency for internal market transactions and will give the euro greater global weight. But a larger EMU is subject to more uncertainty as to how well it will actually function. American observers have warned that tight monetary and fiscal policy in the EMU could plunge Europe into an economic recession. They are concerned that American exports will suffer due to a weak valuation of the euro against the dollar. However, the current problems of the individual Member States’ economies are better seen as a reflection of their performance without the euro than a preview of what we might have to expect from the EMU. Member States aim to improve conditions for economic growth and employment through the euro. Currently, large public deficits and debts-and the resultant high interest rates- are the main obstacle to economic growth in Europe. In almost all EU countries, fiscal consolidation is necessary, regardless of whether the EMU is implemented. Tax reforms and the reduction of subsidies will contribute to a better functioning of the internal market and thus improve conditions for European economic growth in the medium term.

The transition period to the EMU is especially risky for European currencies. Markets will continually test the EMU until the euro is proved to be irrevocable and has gained trust. Exchange rates may be particularly volatile during the transition period. Uncertainty about the EMU’s performance could possibly prompt capital to flow into the dollar. But this is likely to be reversed once the euro is in force.

In focusing on the medium-term implications of the EMU, I am assuming that the EMU will function more or less according to its institutional rules. It is plausible to assume that the independent European Central Bank will stick to its price stability goal. Fiscal policy performance is more difficult to predict. However, by agreeing to the stability pact concluded by the European Council in Dublin and Amsterdam, the Member States have committed themselves to balanced budgets under normal conditions. This is to ensure that public deficits can be kept within the 3%-GNP margin even in less favorable phases of the business cycle. Public deficits are to be monitored and severe sanctions applied if they exceed the 3%-GNP limit. Moreover, national governments will be subject to peer pressure, encouraging them to avoid policies that would require use of the sanction mechanism.

For this reason, we may assume that Member States will continue their efforts to keep their deficits low. They may not always be entirely successful. However, the Reagan pattern of simultaneous tight monetary policy and increasingly large budget deficits is less likely because of the checks and balances built into the system.