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Has The Euro Been A Success?

The most obvious development in the trend toward regional currencies in recent years is the birth of the euro in January 1999, an occasion that was rapidly spoiled as the euro fell against the US dollar. The euro began 1999 at a disappointing 1. 1718 against the dollar and quickly slipped to near-parity rates, dipping as low as 1. 0125 by August 1999. Although the euro showed a steady rise through the end of 1999, the small increase soon evaporated, and the euro has now depreciated by about 25% since its inception. Euro and Stability and Growth Pact

The Stability and Growth act was once likened to a mediaeval torture chamber. Originally conceived by the German government in the mid...

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...-1990s, it was designed to enforce budgetary discipline in the future euro zone, if necessary through automatic penalties against fiscal miscreants. The future viability of the Stability Pact is more than a statistical matter. It touches on the credibility of fiscal discipline in the euro zone. The European Central Bank, a vigilant supporter of the pact, has consistently pointed to its importance.

The financial markets, which once overlooked its provisions, have come to see the pact as the best means of keeping governments on the path of fiscal virtue. So what has gone wrong? The first answer is that euro-zone governments have repeated the failures of their predecessors in the late 1980s. At that time, political leaders failed to trim their deficits during a period of strong growth. In the ensuing economic slowdown, governments had little room for fiscal manoeuvre and every incentive to increase spending to boost domestic demand.

This is particularly true of the centre-left French government led by Lionel Jospin between 1997-2002. Despite enjoying annual growth of 3% or more for most of this period, as well as falling unemployment, Jospin failed to make a serious effort to bring the budget close to balance, in line with the spirit of the pact. Indeed, the deficit barely receded to less than 2% of GDP. The second explanation is that Germany, once the architect and champion of the pact, has had the most trouble meeting its provisions (with the possible exception of Portugal).

The Kohl government barely came under the 3% deficit target necessary to qualify for entry into the euro in 1998. The standoff over Germany’s deficit led to a shabby compromise. Chancellor Schroder escaped a public warning letter from the European Commission in the run-up to the autumn general election. In return, he gave a commitment that his government would come under the 3% target in 2002 and bring the budget close to balance by 2004. Four months later, both promises are now at risk because of lower-than-expected tax revenues and a slower-than-expected recovery.

The third explanation for the slow unravelling of the Stability Pact is that what made good political and economic sense in the run-up to the launch of the euro no longer holds so true in the post-euro world. In economic terms, the Stability Pact looks flawed. Critics point out that it is excessively “pro-cyclical. ” That means that its provisions for automatic sanctions encourage governments to cut spending and raise taxes in a downturn.

Some modifications were agreed upon a year ago to allow “automatic stabilisers” to operate, but only for those governments whose deficit reduction targets were judged to be on track. Ironically, the best prospect for an overhaul of the Stability Pact would be the entry of the United Kingdom into the euro zone. Gordon Brown, the intellectually formidable chancellor, argues that it lacks flexibility. In particular, he proposes a more lenient view of capital spending when measuring budget deficits. Capital spending, he argues, is an investment in contrast to current spending.

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