Friday 17 Aug 2018 | 00:18 | SYDNEY
Friday 17 Aug 2018 | 00:18 | SYDNEY

Euro: The continuing gamble


Mark Thirlwell

27 May 2010 14:29

Parts one and two in this three-part series.

The establishment of the euro in 1999 meant that European governments had responded to the failure of past attempts to eliminate exchange volatility by upping the ante and providing both new institutions and a much greater degree of policy lock-in than before. Indeed, such was the degree of lock-in implied by the adoption of the single currency that it was extremely difficult to imagine how an exit policy would work in practice, given the apparently prohibitive costs involved.

And then a major external shock (the GFC) hits...

By now, the story should be familiar. European governments construct a system to minimise exchange rate volatility. Said system works until it's hit by a big enough shock to break it. European governments construct a new and more ambitious system. Rinse and repeat. 

In other words, forecasting the failure of individual schemes has (eventually) paid off. Forecasting the survival of the underlying project (so far) hasn't. 

If history repeats itself, European governments will respond to the latest crisis much as they have in the past. The existing structures will shift and in some cases may even break (a Greek exit? A two-tier euro?), but will then eventually be replaced by a renovated system with the same end-game in mind, and with even greater institutional support – a replacement for the Stability and Growth Pact, greater fiscal federalism and a European Monetary Fund have all been canvassed in recent months.

Two last things to bear in mind. First, while European politicians seem happy to keep playing this game, they still have to keep an eye on their voters. Second, they need to remember that the strategy of following each failed scheme with another bet and higher stakes is no sure thing.

Photo by Flickr user 1suisse, used under a Creative Commons license.