Daily Archives: May 3, 2012

Amid the eurozone cacophony, the growth rhetoric sounds nicer than the austerity refrain.

But the challenge is to translate rhetoric into facts, especially in countries where market conditions provide no room for deficit spending. Structural reforms are a well-known recipe. While necessary, they take time to produce their effects on growth and employment. So they might not be sufficient to pull the eurozone economy out of stagnation over the next couple of years and to restore market confidence.

The debate needs to take place at a broader level. The foreign exchange market has not worked properly over the past few years and it is increasingly creating obstacles for the European recovery.

The eurozone economy is projected to be in recession this year and to barely stabilise in 2013. The US and Japan have now been growing again for some time, although modestly, and emerging markets are experiencing a soft landing from the crash. This should provide grounds for a depreciation of the euro against other major currencies. The private capital outflows from the eurozone periphery also seem to be pointing in the same direction. A gradual depreciation of the euro would be justified by the loss of competitiveness accumulated by several member countries and the need to reduce the pain associated with the current account adjustment.

Yet such a depreciation is not happening. The reason is that several foreign official institutions, notably the central banks of emerging markets such as China, are continuing to intervene in the foreign exchange market to buy euro-denominated assets at a pace which more than compensates the sales of private market participants.

These interventions are producing two types of distortions. First, they do not allow the external value of the Euro to adjust to underlying fundamentals and thus contribute to a further worsening of economic conditions in the euro area. Second, by investing mainly in low yielding euro assets, the interventions contribute to widen the spreads among eurozone Government bonds and thus fuel financial instability.

These issues can only be addressed directly with the major counterparties, notably China and other Emerging markets, and also other advanced European economies which are pegging to the euro. At times of crises like the one we are currently experiencing, there is a need for stronger cooperation among major economies to avoid beggar-thy-neighbour policies and competitive devaluations.

The eurozone needs to equip itself for such enhanced international cooperation. Unlike  the US and Japan, for example, the competence for the external value of the euro is shared between the European Central Bank and the eurogroup, which comprises eurozone finance ministers. The former is responsible for deciding and implementing foreign exchange interventions, the latter for defining the guidelines of the exchange rate policy of the euro.

Given that the main objective is to convince some of Europe’s partners to change their foreign exchange policies and promote a better functioning of the international financial system, a stronger political stance by European authorities is required. The eurogroup needs to take leadership in in the various international forums where such issues are discussed, bilaterally, trilaterally or in the G7, G20 or the International Monetary Fund. This requires a more efficient functioning of the Eurogroup, in line with the provisions of the Lisbon Treaty.

The problem is that the Eurogroup is currently without leadership, following the resignation of Luxemburg’s Prime and Finance Minister Jean Claude Juncker. Such a vacuum cannot last long. A new President needs be appointed rapidly, with a clear mandate. The selection process should take into account the candidates’ ability to stand up to the other major global powerhouses and defend the interests of the euro area, including by promoting a better functioning of the international financial system.

For the euro to seriously get back on a growth path, it needs to get its interest better represented in the global scene. This requires stronger political institutions, whether comprising finance ministers or Heads of Government, and beginning with the eurogroup. The good news is that it doesn’t require any institutional change. The bad news is that it requires political leadership.

The writer is a visiting scholar at Harvard’s Weatherhead Center for International Studies and a former member of the European Central Bank’s executive board

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