Is Europe an Optimum Currency Area?
Letter to the Editor

In his "Back to Basics" article on the Euro’s fifth anniversary, one would have thought that Mr. Faruquee would have raised the most basic of questions about the relative merits of the idea of a single currency for Europe ("Euro Turns Five: Europe’s Grand Experiment"). Does Europe remotely satisfy the criteria for an optimum currency area and, if it does not, what does Europe need to do to bring itself closer to meeting those criteria?

This question would seem to be of present relevance in the face of the very lackluster economic performance of Germany, Europe’s largest economy, which is presently suffering from the lack of an independent monetary policy to stave off deflation. It would also seem to be of relevance to the question as to whether it makes sense to include in the Euro experiment yet another ten countries. Those countries are economically even more diverse than the original 11 countries that adopted the Euro in 1999, which will only add further strain to the ECB’s one monetary policy fits all experiment.

Historic experience suggests that a currency union similar to that of the Euro will only hold together if that union satisfies the criteria of an optimum currency area. Among the more important of those criteria are economic homogeneity among members, wage flexibility, labor market mobility, and a system of federal fiscal transfers. Can one really say that Europe satisfies those criteria? Can one really be so sure that over the next five years Europe will not be subjected to an asymmetric shock that will reveal the weak economic underpinnings of Europe’s Grand Currency Experiment?

Desmond Lachman is a resident fellow at the American Enterprise Institute.

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