Let me begin by acknowledging what a remarkable achievement monetary union has been to date. Europe’s progress toward a single currency over the postwar period has been likened to the emotional roller coaster of a television soap opera: every advance accompanied by inflated rhetoric about Europe’s glorious future; every setback greeted with exaggerated predictions of conflict and disaster. But with the changeover to euro notes and coins, the drama has successfully reached its “season finale,” thanks to determined political leadership and economic convergence. The challenge now is to ensure that this positive political and economic momentum is maintained in the years to come.
Positive momentum must be maintained
Fortunately, macroeco-nomic policy in the euro area is built upon firm institutional foundations. Despite initial skepticism in some quarters, the European Central Bank (ECB) has clearly established its independence and commitment to price stability The ECB faced a difficult policy environment last year, with growth slowing and inflation above its target range. It responded appropriately, lowering interest rates modestly to begin with and then responding more resolutely when September 11 unsettled financial markets and dealt a blow to business and consumer confidence.
Economic turning point
We now appear to be at or near a turning point in global economic activity—always a difficult juncture at which to set monetary policy. For now, the risks to medium-term price stability seem pretty evenly divided. If recovery proves sluggish, additional easing could be required. But the inflationary impact of an unexpectedly rapid recovery or a move away from wage moderation could argue for a touch on the brakes. For the time being, watchfulness is the key.
Macroeconomic policies focused on stability are a prerequisite for strong growth and job creation. But they are not sufficient. The external weakness of the euro seems to reflect the relative equity boom in the United States, portfolio shifts, and a current account position that has not reacted in typical fashion to the depreciation. But it may also reflect, in part, a belief among market participants that productivity growth will remain lower in Europe than in the United States in the years to come. An important challenge for European policymakers will be to try to prove them wrong.
Unfinished structural reforms
At the Lisbon summit in March 2000, European leaders adopted the goal of creating over the next 10 years an economy with integrated, employment-generating, and smoothly functioning markets. This will be important to boost productivity growth and increase the economy’s potential output by reducing structural unemployment. Progress to date has fallen short in a number of areas. We must hope that the creation of the euro—and now its physical manifestation in notes and coins—proves a spur to the area’s longstanding structural reform agenda. If policymakers allow the loosening of exchange rate and current account disciplines to enervate the reform process, then all Europe’s citizens will be the poorer for it.
Broader and deeper structural reform is required in a number of areas. For example, growth and job creation in Europe are hampered by labor market rigidities, overstretched and expensive social security systems, and subsidies that hinder efficiency and weaken fiscal positions. A study in the IMF’s World Economic Outlook of October 1997 suggested that more rapid structural reform could deliver a growth premium of about 5½ percentage points over a 10-year period, helping reduce unemployment by 4 percentage points from a slow-reform baseline. To date, alas, this premium appears to have gone unclaimed. Further reforming labor and product markets is unavoidable if the European economy is to achieve the productivity growth rates that it is capable of.
If monetary union is to enjoy high levels of public confidence—and to be attractive to potential entrants—then it will have to be seen to contribute to greater economic stability and higher living standards for Europe’s citizens. This means getting macroeconomic policy right and accelerating structural reform. No one should underestimate the magnitude of what has been achieved to date, but neither should anyone underestimate the magnitude of what remains to be done.