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June 15, 2010
The Living Euro
By Cindy Ivanac-L.
I happened to be living in Bologna in 2002 when Italy officially switched from the lira to the euro. It was a bit chaotic the first few weeks. One day a kilo of apples was 3000 lira (about $1.50), and the next day it was 3 euro (at that time roughly $3). After about 90 days, things seemed to settle down and the seniors of Italy were no longer holding out their change purses asking vendors to take the money out by themselves. It was an extraordinary experience to live through. (My only personal gripe was, and still is, that the lowest denomination of paper currency is 5 euro – this creates a lot of heavy change to carry!)
As luck would have it, I was in graduate school at the time and studying macroeconomics. In theory, you learn that there can be only one monetary policy for a currency. The participating countries had in fact given up their ability to enact their own monetary policy when they joined the euro. For many, including many Italians we knew, this was welcome news. I would say many southern European countries were glad to give up their own monetary policy. They had experienced rather intense bouts of inflation in the 20th century and in some cases had difficulty creating monetary authorities independent of politics.
The creation of a common currency in Europe sparked a debate that still endures: Does a monetary union require an eventual political union? The answer is probably still unknown. During workshops in the U.S., I have asked students to think about our country as a monetary union, with every state having the same monetary policy even though the state economies themselves are pretty different. However, we have fiscal policies/mechanisms on a federal level that can and do treat states differently.
During our recent financial crisis, states fared very differently. Without a flexible fiscal policy, things may have been much worse. Compare this with the relatively young euro, currently facing its first serious crisis. All of this news about the trouble facing the euro seems to reflect the euro countries attempting to figure out how to address the fiscal disparities among members -- with everyone else watching to see if it what they come up with is sustainable. There was always debate about whether or not they needed a political union in good economic times, but this crisis may add a new level of debate to the decade-old conundrum. I always tell students and teachers that it is a gift to study economics now, as we are witnessing a major transformation in the euro, and the ideas that gave birth to it are still very much alive and being debated.
To learn more about the euro from an academic standpoint, please visit www.euro-challenge.org, which has many wonderful resources dedicated to students and teachers. Many of the resources are designed for a program called the Euro Challenge we co-host with the Delegation of the European Union to the U.S., but the materials can be used by anyone. There are also great historical and analytical pieces on the site. For those more interested in the political aspect of the euro, there was recently a provocative blog entry in the NY Times called, The Euro's Lost Promise. Regardless of whether you agree or not with the author, the historical account he presents is an interesting read.
Let me know what you think – what is the interplay between monetary policy, politics and fiscal policy? Will a monetary union demand a political one in the future? What are the pitfalls?
Posted by Cindy at June 15, 2010 4:21 PM
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Here's an interesting editorial to consider when you think about the current Euro crisis (copy and paste into browser): http://fedreserve.fp.factiva.com/pagebuilder/viewarticle.asp?folderid=584&AN=NYTF000020100621e66l00038. Will also try to find the opposite perspective.
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