the Euro Filling the Half Full Water Glass scott menchin all I In January Europe s monetary union will mark its fifth anniversary However the congratulations are not exactly pouring in For there is seemingly little to celebrate growth in the countries of the euro area has been significantly slower than in the United States in recent years while unemployment over much of the continent remains stubbornly disturbingly high Indeed in the view of many the euro has only compounded Europe s myriad economic problems By Barry Eichengreen Fourth Quarter 2003 47 the euro If anything the volume of grumbles is rising In the first few years of the monetary union Europe s growth was sustained by booming stock markets which were almost as irrationally exuberant as their American counterparts and then by the depressed exchange value of the euro which gave the continent s exports an artificial boost But now that the both the stock markets and the value of the euro have returned to realistic levels Europe s problems are mounting And even some erstwhile champions of the single currency are having second thoughts the promise Almost everyone would agree that the euro has in part delivered on its promise One tangible benefit has been the deepening and widening of Europe s financial markets By eliminating exchange rate fluctuations within the union the euro eliminated the currency risk that previously segmented Europe into a dozen or more separate corporate bond and commercial paper markets Indeed with monetary unification the German bund the Federal Republic s 10 year government bond became the benchmark on which corporate debt could be priced throughout the euro area No longer worried about the risk of currency fluctuations within the member nations investors began searching out the most attractive corporate debt securities regardless of the national market in which they were issued The result has been a more liquid continent wide market Almost immediately then the euro began narrowing the competitive disadvantage created by Europe s lack of U S quality bond B A R RY E I C H E N G R E E N is George C Pardee and Helen N Pardee Professor of Economics and Political Science at the University of California Berkeley 48 The Milken Institute Review markets Funding costs for European corporations declined as the rate of issuance of new securities exploded In the first year of the monetary union the value of euro denominated corporate bond issues more than tripled compared to the amounts that had been denominated in the old legacy currencies And the share of new corporate bonds in the high yield sub investment grade category rose from 4 percent to 15 percent The extraordinary growth rates of the markets have since tailed off but the issuance of corporate debt continues to outpace the growth of their other sources of capital Note an indirect benefit easier access to debt markets has helped to finance a wave of mergers and acquisitions which promises to strengthen Europe s corporate sector As with many economic adjustments there have been losers as well as winners Europe s banks confronted with fiercer competition from the bond market have seen their profits squeezed Indeed banking has gone from top dog to dog house in a few short years It s worth pointing out though that the decline was overdue Europe was overbanked and U S corporations enjoyed a cost advantage as a result of America s more efficient capital markets The end product will undoubtedly be a better balanced European financial system and a more competitive private sector A second benefit of the euro is stimulus to price competition Europeans may have reservations about cutthroat competition la Am rique but it is hard to deny that more competition was needed to spur the productivity of European retailers and their suppliers In fact with just this goal in mind policymakers have been pursuing what s called the Single Market Program for nearly two decades But a true single market is easier to declare than to establish And the existence of a dozen Euroland can at least take heart that this different currencies plainly complicated specter has been vanquished cross border price comparisons and reduced the cost the intensity of competition With the euro residents of different European countries can But what ifs rarely sway public opinion finally compare apples with apples They can when the costs of the policy in place are palmore easily determine where prices are lowpable The most fundamental constraint of est and vote with their feet or Web monetary union is that the central bank must browsers Europe is still set uniform interest rates for REAL GDP GROWTH far from the competitive the entire zone And the effect SINCE THE START OF 2002 ideal of textbook economon Europe has been to accenPERCENTAGE CHANGES ics but it is closer than it tuate the boom and bust 1Q 2002 2Q 2003 was five years ago cycles experienced by individEURO AREA U S It is also worth ponderual national economies In GDP 0 8 2 7 ing the counterfactual Ireland growth more rapid Consumption 0 9 2 8 Government Spending 2 2 3 8 that is how events would than the European average Investment 1 9 1 6 have transpired had the also meant inflation above Exports 1 4 2 3 members of the euro area the European average But note The 2nd quarter 2003 figure for the retained their national since the level of market euro area is an estimate based on Germany and France currencies Europe s histointerest rates was necessarily source JP Morgan Global Data Watch ry is replete with instances the same throughout Euro August 29 2003 p 7 in which economic and land the real interest rate the political shocks led to sharp changes in curmarket rate minus the rate of inflation was rency exchange values undermining ecolower in Ireland than elsewhere nomic stability A classic example is GerThe perverse result was that firms in many s reunification after the fall of the Europe s fastest growing country effectively Berlin Wall which was a major factor in the had the lowest cost of borrowing further currency crisis of 1992 stimulating Ireland s already overheated Now imagine a shock like the recent milieconomy The opposite was true in Germany tary action against Iraq which raised diplowhere slow growth meant low inflation and matic tensions between the U S and France hence high real interest rates But the In this riskier political environment investors European Central Bank which set monetary might have fled the French franc for
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