Winnipeg Free Press

Winnipeg Free Press (Newspaper) - July 16, 1997, Winnipeg, Manitoba Brian Cole 6977044 focus Winnipeg free press 4 4 july 1997ft i i european governments face problems of moving to a single euro the economic Wolf behind the numbers is a regular feature exploring economic today Norman Cameron discusses the issues involved in the move to a single european t Thile the world is never Dull for a Macro economist some some is always starting something new and it is now unusually interesting in most of the european governments seem trans fixed by the problems of How to meet the maastricht Accord criteria for moving to a single currency the euro in the austerity Mea sures required to keep deficits Down to mention just one criterion at a time of High unemployment Are Caus ing lots of political frictions both within and Between nations of the proposed single currency Small the stakes involved in moving to a single currency Are the issues unusually Complex even for As it is currently moving to the euro Means abandoning most of each country control Over not Only its interest rates and Exchange but also its government spending and taxation this is because moving to the euro is a package consisting of both adopting a single currency and agreeing to the set of restrictions in the maastricht Accord of the two parts of this package Are in principle even though european politicians seem very reluctant to think of them to understand the current european turmoil Over the it will help us to consider first a single currency and then the restrictions of the maastricht a single currency arrangement is what we have in All 10 provinces use the same pay the same interest and face the Sirte Exchange rates with the rest of the this very familiar arrangement can be compared to two alternatives either a fixed Exchange rate system of separate currencies that Are pegged in a tight band As in the Exchange rate mechanism to which a Core of european nations still or else the floating Exchange rate system we use now Between the United Mexico and Many other coun Why might Europe prefer a sin Gle currency arrangement to either of these alternatives consider first a fixed Exchange rate this is the same As a single currency system except for one big difference the Exchange rate Between currencies is fixed As Between loonies and but Only temporarily the government can unix a fixed Exchange rate overnight and fix it again at a new and much different the Prospect of such overnight changes attracts lots of who often bet enormous sums on whether a government will choose to adjust a fixed Exchange rate whose level has become a by the Exchange rate Between member nations currencies in a single currency system is automatically and always one to As Between Nova Scotia dollars and Manitoba since each nation has Given up the ability to print its own currency like Nova Scotia and no rational investor could expect any government to devalue so finance ministers in the single currency system need not worry about huge flows of Specula tors funds flowing in to or out of their financial Given How huge speculative flows have become since foreign Exchange controls were abandoned in Europe in the Early not having to worry about them is a big Relief for the finance that explains Why the european nations currently in the pegged Exchange rate system would want to move to a single cur what about choosing Between the single currency euro and a system of separate floating currencies on this Side of the we use a sin Gle currency for All the Canadian but we prefer separate currencies for the and which is better for Europe this is a Tough to answer economists look at whether or not european economies would react better to various types of Shock under a single currency system than they would with floating Exchange the answer is the usual answer for Tough problems it depends to Start with there is a Small presumption in favour of the behind the numbers Norman Cameron single because Ordinary transactions Are simpler with no cur Rency but that advantage can easily be outweighed if belonging to a single currency sys tem prevents the Economy from adjusting easily to shocks and there fore dooms it to either prolonged inflation or prolonged consider first a demand suppose there is a surge of demand for output in Germany from spend ing unleashed by reunification of East and West Germany and a slump in demand in Belgium from dismantling of belgian government hand other things German employment and inflation would while belgian employment and inflation would a Rise in the deutschmark belgian franc Exchange rate would lower demand for German outputs and German employment and raise spending on belgian outputs and belgian the Exchange rate fluctuation can smooth out what would otherwise be larger swings in employment in the two if workers can move from Belgium to Germany and Back As easily As Between Winnipeg and then the employees can move to where the spending is and the countries do not need a flexible Exchange rate to move the spending instead to the consider a suppl Side suppose that Germany is losing mar Ket share in european markets because German wage increases Are outstripping productivity while Portugal is gaining Market share because portuguese productivity is outstripping nominal other things rising German costs will lower German employment and falling portuguese costs will the political Factor makes financial shocks seem very raise portuguese to keep employment either a German prices and wages must fall and portuguese prices and wages or b the deutschmark or Puguese escudo Exchange rate must both would restore Germany competitive position and help Ger mans keep their if German and portuguese prices and wages could adjust easily upwards and Down then neither would need to have the Exchange rate adjust it seems to take a severe recession to Force wage con Cessions on workers in which Means european nations adjust much better to shocks like this one if they have floating Exchange to see the example above in a cur rent Canadian just replace Germany and Portugal with Cape Breton and Southern Cape Breton wage rates seem incapable of falling far enough to restore Cape bretons and it has no Independent Exchange rate to adjust so Cape Breton is stuck with very High unemployment rates even when Southern Ontario has booming one can imagine Many other shocks buffeting Europe in the future most of the economic shocks will look like one of the two examples above demand shocks to total spending or Supply shocks to relative there is an important third Many shocks can be financial shocks that directly affect Supply and demand for financial such As German rather than Supply and demand for German output of goods and in a floating Exchange financial shocks All affect output and for foreign lenders shifting their Bond portfolios out of German Bonds would lower the value of the improve Germany competitive and increase Germany net exports to the rest of which would raise German output and employment in a single currency system by such financial shocks could not change the value of the and therefore could not change Germany competitive position or net exports or output an italian currency trader above wont have to worry about sudden fluctuations when the euro replaces currencies like the lira and deutschmark or after these three what conclusion can one reach about whether a single currency is a Good thing for the european economies if european financial markets Are prone to big swings in demand for different nations financial assets especially where those swings Are because of changes in a stations it future a single cur Rency system with its permanently fixed Exchange rates will look if the Economy is subject to significant shocks in total spending or in relative and has relatively immobile workers and relatively Sticky wage a floating Exchange rate system will look much better than the alternative of fre quent Long bouts of inflation or the political Factor makes Finan Cial shocks seem very Likely in a floating Exchange rate one of the possible sources of shocks to demand for a nations Bonds is changes in the interest rates of Neighbour for a fall in italian interest rates would drive up the portuguese escudo ital Ian lira Exchange and drive Down portuguese exports and the italian govern ments Low interest rate policy could in effect steal some employment from Portugal As from All of Italy other trading this is understandably tempting for govern ments close to by a single currency sys Tern removes the political temptation to steal jobs from abroad by removing each nations ability to set its interest rates a single currency system has Only the one Central Only the one Short term interest part 2 of the euro package is that the european governments also agreed to set limits on each country taxing and spending policy most budget deficits should not exceed three per cent of National and accumulated government debt should not exceed 60 per cent of National it is to meet these two criteria that Many european nations have been pruning raising and Selling off state assets to private Many commentators blame the recent electoral Victory of the French left Wing on the High unemployment Levels which these policies caused in Why Are such restrictions on debt and deficits needed in the Canadian single currency we do not constrain provincial governments to keep budget deficits below three per cent of provincial or Provin Cial debts below 60 per Provin Cial governments Are Only accountable to their electors every five years and their creditors through reports of International Bon rating if a province runs into a severe races its government can run deficits of any size that creditors will finance in order to pump demand Back at the National Japan has been doing just this for the last seven running deficits far larger than would be possible under the maastricht in the concern is that irresponsible spending decisions will cause a flight of capital from the driving its value Down in foreign Exchange mar such flight would occur for two some foreign investors would flee from italian Bonds into Canadian or Bonds if one expects Italy to be bailed out by the rest of Europe then one is expecting Europe credit to be extended to accommodate Italy to validate irresponsibility and Many lenders would flee that flight of lenders capital would lower the euros value and therefore raise the Cost of imports and lower the Stan Dard of living for everyone in the sin Gle currency whether italian or we would have the same situation in Canada if one province were to spend itself so far into debt that it had to be bailed out by the other we do not worry about that very much in Canada because we by and Large Trust either our elec toral system or our financial markets to discipline governments that Start Down that europeans do not have such Confidence about the governments of All the member states that could belong to the single cur Rency so they want the extra safeguard of explicitly forbidding any Large deficits by the european safeguard is a Little like the solution in the childrens Story of the boy who cried the boys Village solved the problem of the boys bogus Wolf alarms by not listening to his alarms any whether real or of course the Village had a problem when the Wolf really did and the europeans will have a problem when a Large deficit really is needed to maintain the social safety net and restore some so far the discus Sion on this Issue Between the French socialist government and the right Wing German government has consisted of the French socialists raising the question and the German govern ment asserting that a larger deficit will never be needed that the Keyne Sian theory which suggests such actions is outdated and that the Wolf will never Norman Cameron is a professor of eco flows a the University doonesbury by Garry Trudeau ;