Time to change the rules
Dec 18th 2008
The EU is asking too much of the ex-communist states that want to join the euro
MOST people who give the matter any thought agree: one of the main rules for countries wanting to join the euro is perverse. Yet adopting the common currency has gone from seeming a matter of national pride to national necessity, as the financial turmoil has highlighted the costs and risks that small countries face by keeping their national currencies. For places like the Baltic states and Bulgaria (which already peg their currencies to the euro) maintaining the current regime carries extra burdens and no benefits.
But euro-adopters must meet a European Union (EU) rule that stipulates a “high degree of price stability”, meaning that inflation must be no more than 1.5 percentage points higher than the three best-performing countries. (The other rules are less controversial. The second is sound public finances, meaning a government deficit below 3% of GDP and government debt below 60%. The third is stable exchange rates and the fourth is low long-term interest rates.)
The inflation rule is arbitrary in the sense that the benchmark is not the performance of the three best-performing (ie, lowest-inflation) countries actually in the euro zone, but rather the best three in the entire EU. So to join the euro, you might have to lower your inflation to the level of three countries that don’t use the common currency (eg Britain, Sweden and Denmark).
It is also harsh: as poor countries (such as the ex-communist states of eastern Europe) get richer, they should enjoy an appreciating exchange rate if their currency floats. But if they have their currency pegged, then it can’t appreciate. So prices and wages measured in the local currency will rise instead (economists call that the Balassa-Samuelson effect). That is not inflation of the kind that the euro zone’s managers should mind about.
Thirdly, the risk now is that the three benchmark countries may be suffering deflation. That is a nasty state of affairs which most countries would do much to avoid (because it leads consumers to postpone consumption while they they expect prices to fall further, thus triggering a long slump). It would be truly bizarre if countries battling for survival were to force deflation on themselves willingly.
So what to do? Andrus Ansip, Estonia’s commendably blunt prime minister, recently questioned the value of the current approach. But the European Central Bank and the EU’s monetary minders are not in the mood for treaty-tweaking. A better idea would be for the non-euro countries in the EU (ie, all the ex-communist ones bar Slovenia and Slovakia—plus Britain, Sweden and Denmark) to get together and warn the ECB that they will support any member that adopts the euro unilaterally. Then Estonia, Latvia and Lithuania, for example, could euro-ise on their own. Countries with currency boards and similar arrangements can do that almost at will: the money in circulation is covered by the central bank’s reserves, so you just substitute one for another.
That would turn the tables on the gnomes of Frankfurt. But it requires leadership. Only with one or more big countries—preferably Poland and Sweden—giving the small countries political cover will they have the nerve to take a step like this. The ECB could complain loudly, while privately accommodating the change. Then it would say that it had to change the rules to reflect the fait accompli.
This would not solve the underlying problems of the euro zone. Nor would it cure the ex-communist countries’ economic hangovers, which are the result of reckless borrowing and slow reforms. But it would at least remove the risk that some of the most vulnerable countries in Europe’s east suffer needless harm—at a time when the rich half of the continent is ill-placed to help them.
Thursday, December 18, 2008