Why a Single Currency Works in the US, but Not Very Well in Europe: Three Minimal Conditions for the Eurozone to Function

© 2015 Prof. Farok J. Contractor, Rutgers University

America has been using a single currency since 1793, when the United States Mint in Philadelphia first began issuing US dollar coins. However, it is not the longevity of a currency that determines whether it succeeds, but institutional mechanisms. Such mechanisms are weak or lacking in Europe. To understand why, we need to examine how such mechanisms could help countries in a common zone to ride out economic cycle “booms and busts.” When a country gives up its own currency (say, the drachma) in favor of a supranational one (such as the euro), it loses two important levers to help soften the blow of a recession: (1) It cannot unilaterally adjust its interest rates downward to stimulate its own economy in a downturn; interest rates could be held uncomfortably high by the supranational monetary authority if the economies in the other member states remain healthy. (2) And it is unable to devalue its currency in order to stimulate the nation’s exports. For a single currency to function well, three conditions, or institutional pillars, must be in place: (1) fiscal discipline by member states, (2) labor and capital mobility, and (3) inter-regional balancing through transfer payments managed by a central government.CONTINUED ON ARCHIVE

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