Euroland not the Best Optimum Currency Area but Monetary Unions Now Work Better

At a CEPR Lunchtime Meeting on Tuesday 5^th June, Jeffrey Frankel argues that an early evaluation of EMU suggests success on some dimensions – but failure on others. The transition of January 1999 was a success. Acceptance of the euro as the number two international currency has been a success. EMU’s contribution to the integration of Europe’s money markets, securities markets and banking has been a success. The failure, of course, lies in the weak value of the euro over the first two years. There is no direct connection between international use and the value of the euro in the foreign exchange market. The supply of euro assets has been as high as the demand. Furthermore, the fall in the dollar/euro rate may represent an ‘overshooting of the overshooting equilibrium’.

Frankel further argues that some criticism of how the ECB has been doing its job is overdone. The three common critiques – democratic deficit, lack of transparency and a need to speak with one voice – are in fact mutually inconsistent.

Frankel states that most American economists retain some scepticism regarding EMU. It remains true that Europe satisfies the criteria of Optimum Currency Area theory much less well than do the states of the United States. Workers will not readily move from Italy to Ireland, despite the wide current gap in employment opportunities. Therefore, it is onerous economically for the two countries to have to share monetary policy.

Nevertheless, monetary unions look better now than they used to. Frankel draws on joint research with Andrew Rose to argue that currency unions promote trade and thereby long-run growth. Their estimation suggests that if Poland adopted the euro, its trade with EMU countries might eventually triple, its overall openness would double, and its income per capita would rise an estimated 20%. The drawback is loss of any ability to use independent monetary policy for macroeconomic stabilisation. But as trade among currency union members increases, business cycles synchronise and the need for monetary independence diminishes.

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Jeffrey Frankel is Harpel Chair at Harvard University’s Kennedy School of Government and directs the NBER programme in International Finance and Macroeconomics. He served as a Member of President Clinton’s Council of Economic Advisers (1996-99), with responsibility for international economics, macroeconomics, and the environment. The views expressed are the speaker's own and do not reflect the views of CEPR, which takes no institutional positions