Why EuroZone Countries Keep Failing
When the EuroZone formed in the late 1990’s, there were many critics of the Union’s creation, but perhaps none was as outspoken as economist Milton Friedman. Friedman is remembered as the most renowned economist of the late 20th century, and when the euro was first introduced, he adamantly stated that the EuroZone would not survive through its first major recession.
His argument was simple. He did not believe that a 16-nation currency bloc could survive without a single fiscal policy. The constraints of EuroZone monetary policy would inevitably serve to help some countries, while simultaneously helping other countries. Let’s break down this argument into real-world events.
Central Bank Action
In the modern economic model that rules the developed world, when a country [or in the case of the EuroZone…countries] is facing recession and deteriorating economic conditions, a Central Bank will lower interest rates in an attempt to ease credit markets and spur economic growth. Conversely, when an economy is growing very well, and begins to grow too fast, then inflation becomes a threat, and when inflation becomes a threat, a Central Bank must increase interest rates in order to curb economic growth and stem inflation.
This is how the Federal Reserve operates in the United States, the Bank of England in the U.K., the Reserve Bank of Australia in Australia, and other Central Banks around the world. How is the European Central Bank supposed to operate, though? It doesn’t have only one country to take into account; rather, it has 16 nations to take into account. How can the European Central Bank satisfy the needs of every country? This was the primary objection of Milton Friedman.
The Global Credit Crisis of 2008
When the Crisis of ’08 erupted, every country in the developed world, for the most part, was thrust into recession and financial Armageddon at the same time. The United States, Germany, Canada, Australia, Greece, Portugal, and Spain—they were all in major trouble. Therefore, the response of every Central Bank was the same—slash interest rates! The United States slashed rates to near 0%, the U.K. to 0.5%, the EuroZone to 1.0%, and forex brokerage firms were forced to widen their dealing spreads as a result of the wild volatility that unfolded.
Interest rates needed to be slashed in order to fight off another Great Depression, and the concerted and unified effort of Central Banks around the world did act to stave off another Great Depression. However, the response to the global economic recovery was different in every nation around the world. Every country plunged into recession at the same time, but every country emerged from recession at a different rate of velocity, and this is where the problem lies. How does the European Central Bank satisfy the needs of all these 16 countries who are emerging from recession at different speeds. Furthermore, some EuroZone countries are still in recession! This is a major challenge.
Therefore, Germany is going to need much different policy than Greece. Germany may be facing inflation and need a stronger currency, but Greece may be facing deteriorating conditions and need a very weak currency in order to stimulate growth. This dilemma has been a major cause of trouble in the EuroZone, and so far two countries have suffered sovereign default—Greece and Ireland.
So, what is the solution? Some believe that struggling countries such as Greece and Ireland must be allowed to peacefully exit the EuroZone, reinstitute and devalue their national currencies, and then attempt to regain a competitive edge economically. Other possible solutions are being debated behind closed doors, but the consensus opinion, largely, is that something must be done to help these struggling EuroZone countries regain a competitive edge economically.
by Jonny Pean
