The Impending Collapse of the European Monetary Union

Abstract

European monetary union will centralize control over European currency. Some have argued that the scale of this new currency area will cause a leap in demand for European currency as a numeraire and store of value. Furthermore, reductions in transactions and hedging costs from currency homogeneity within Europe could increase European wealth and income. It is argued that this change would be beneficial to the world economy, not just to Europe. Giving other countries the ability to peg their currencies to a basket of hard currencies (say, a mix of the dollar and the euro), rather than just to the dollar, might stabilize fixed exchange rate regimes. For example, pegging to a bundle of currencies could take the form of a currency board that redeems a fixed bundle of ‘‘hard’’ currencies in exchange for the domestic one. A bundle of currencies is potentially superior as an anchor because its value is more stable. A productivity shock in the United States that produces a real exchange rate appreciation for the dollar won’t produce as large an imbalance with emerging market countries if the hardcurrency bundle includes the currencies of countries other than the United States which are not experiencing that productivity shock. So a stable European currency could contribute to overall financial stability. Furthermore, the introduction of the euro could produce a onetime depreciation of the dollar, which immediately could take some pressure off emerging market countries pegged to the dollar.