Improving the euro.

• Position: A SYMPOSIUM OF VIEWS

If you were a European economic policy leader with a time machine and could roll back the clock to the late 1990s, what if anything would you do differently with the introduction of monetary union and the euro? In retrospect, what changes would have been both constructive and politically feasible? And if you would not have proceeded with the common currency, what reason would have driven your decision?

JORG ASMUSSEN

State Secretary, Federal Ministry of Labour and Social Affairs, and former Member of the Board, European Central Bank

Let me start with a clear answer: If I could roll back the clock to the late 1990s with a time machine, I would create the single currency again. The creation of the Economic and Monetary Union, culminating in the launch of the euro in 1999, was a landmark in European integration. EMU reflected both economic and political aspirations, and the euro became the most tangible symbol of European integration.

EMU involved a unique architecture combining a centralized monetary policy conducted by the European Central Bank with largely decentralized fiscal and economic policies implemented by the participating member states. As the adoption of a single currency would eliminate the disciplining factor of exchange rate risk premiums and was expected to reduce the disciplining factor of interest-rate risk premiums, the risks of countries attempting to free-ride by running budget deficits without taking into account long-term sustainability considerations and possible negative spill-over across the monetary union was recognized. In addition, it was acknowledged that in the absence of the possibility of exchange rate adjustments and a cross-border fiscal transfer mechanism, and given the likely limitations in alternative adjustment tools (stemming from low labor mobility and price and wage rigidities), divergences in business cycles could create tensions among member states and hamper the effectiveness of a single monetary policy.

Therefore, the founders of EMU specified four strict convergence criteria that member states had to fulfil in a sustainable manner before entering the euro area: Price stability, exchange rate stability, sustainable public finances, and long-term nominal interest rate convergence. The convergence criteria were already being criticized at the time of inception for being arbitrary, too stringent, or inadequate in ensuring the needed discipline. This criticism was partly justified. The deficit level, for example, was much more prominent than the debt level, even though the latter was much more important for long-term fiscal sustainability. The main weakness in my view is the focus on nominal convergence, which diverted attention from factors that matter for real convergence, notably productivity and competitiveness developments, the composition of growth supporting the catching-up process in some member states, and private sector balance sheets. Indicators to be used could have been GDP per capita or real unit labor costs.

The same was true for the instruments available to ensure fiscal discipline once the euro had been adopted, in particular the Stability and Growth Pact. Again the developments in the real economy were neglected, something that became evident in the case of Spain much later on.

These deficiencies were not corrected regarding the convergence criteria, which have remained unchanged since the start of the whole project, while the Stability and Growth Pact was complemented by the so-called Macroeconomic Imbalances Procedure in 2011, with the aim of identifying potential risks stemming from the real economy at an early stage.

The crisis that affected a number of member states in the euro area demonstrated that EMU was an incomplete monetary union. The aim now is to complete it. The report "Towards a genuine Economic and Monetary Union" by the president of the European Council in collaboration with the president of the European Commission, the president of the Eurogroup, and the president of the European Central Bank shows the way forward: The creation of a banking union as the crucial step to break the sovereign bank nexus, followed by a real economic union, a fiscal union, and a democratically legitimized political union.

HANS-WERNER SINN

President, Ifo Institute for Economic Research, and Professor of Economics and Public Finance, University of Munich

What is the most important problem for the eurozone? Clearly, the competitiveness and debt crises in southern Europe, both of which resulted from inflationary credit bubbles. Excessive capital imports ended up burdening the southern countries with unsustainable debt and making them too expensive. To solve their competitiveness crisis, they now need to deflate to lower their overblown prices, in some cases by 30 percent or more. However, that will drive many debtors into bankruptcy, cause unsustainable mass unemployment, and bring the unions to the barricades.

To cut the Gordian knot, Europe needs a debt conference to forgive some of the bank debt, the government debt, and the debt built up between the central banks (Target debt). Also needed is a program for orderly temporary exits from the currency union to realign exchange rates. Re-entry after the realignment and after structural reforms are completed should be envisaged.

Once these immediate measures are implemented, the rules of the Eurosystem as such need to be amended so as to discourage excessive capital flows and avoid the emergence of renewed bubbles in the future. First, new rules for state bankruptcies are necessary to clarify the procedure for the provision of debt relief. Second, the European Central Bank has to abstain from acting as a lender of last resort for regional (member-state) debt, following the rules of the U.S. Federal Reserve and the Swiss National Bank, which would never bail out states or cantons. Third, an internal gold standard for settling the inter-district imbalances between national central banks is necessary, such as the one that existed until 1975 in the United States, so as to make the ECB's bail-out with the printing press less likely in the future. All these measures will make it convincingly clear to investors that bail-outs are not an option, prompting them to demand higher yields from states that borrow too much. The higher interest rates will in turn prevent excessive borrowing and the emergence of new inflationary credit bubbles.

In the long run, Europe could and should develop along the lines of the Swiss confederation, that is, creating a common state with a common government, parliament, and army. Only after that should it develop into a fiscal union, but hopefully never into a debt union, in order to avoid the terrible consequences that Alexander Hamilton's debt mutualization program brought to the United States around the 1840s. At that time, twenty-nine states and territories went bankrupt because debt mutualization had encouraged them to borrow excessively. This added to the tensions that later drove the United States into a devastating civil war. It would be wise for Europe to learn from the U.S. experience.

MIROSLAV SINGER

Governor, Czech National Bank

Let me start by observing that there are only twenty-four hours in a day, even for the European political and economic elite. The members of that elite therefore tend to have time to pursue just one grand project on top of their mundane tasks. The question is, then, whether forming the eurozone was the right way for the European elite to invest its time around the end of the last millennium.

The euro crisis is mercifully receding, but our relief has caused us to forget the two original main selling points of the common currency. First, the euro was meant to speed up growth by making the economic area work more efficiently, allowing it to compete with the fastest developing areas of the world in terms of growth and prosperity. Second, it was supposed to foster further political integration and mutual recognition and friendship between European citizens of different nations.

Let's face facts. Yes, the damage caused by uncontrolled dissolution of the eurozone would be dramatic, and certainly higher than the costs so far of keeping the eurozone together. But the eurozone has been a manifest failure in both its noble goals--prosperity and friendship. Growth is stagnating in both the eurozone and the European Union as a whole. Meanwhile, tensions are mounting between the "South" and the "North."

Why? Because the eurozone was a project implemented by politicians and supported by economists motivated by overblown expectations about the allocation efficiency and trade gains the common currency would deliver. The reality is that we live in a world in which the costs of information transfer and computing are plummeting. As a result, the gains arising from better price comparability across the single currency area are shrinking substantially over time. For example, trade between the United Kingdom and Germany is growing much faster than trade between France and Germany, and the share of exports to the eurozone in total German exports is steadily falling.

What is more, goods trade stems essentially from industrial production, yet industry accounts for a much smaller share of EU economic activity than services. So, instead of the eurozone, a single services market would have been a far more successful path to prosperity.

As to friendship, the outcome could hardly have been worse than the current state of relations between the eurozone nations. Relations between the policymakers responsible for this outcome remain, of course, as cozy as ever.

JOSE DE GREGORIO

Professor of Economics, University of Chile, and former Governor, Central Bank of Chile

The monetary union was certainly incomplete. In hindsight, clearly the absence of a fiscal and banking union aggravated the crisis to the extreme that put the euro in serious risk of collapse. This lack of full...