Philadelphia Reflections

European Common Currency

Christian Noyer

Philadelphia had the recent pleasure of a visit by Christian Noyer, the Governor of the Banque de France, offering to a Federal Reserve Bank audience a view from inside the Eurosystem's monetary policy. Mr. Noyer was a designer of the Euro, or common currency of Europe. A charming and polished man of education, he brought along a document which hangs in his office, dated June 5, 1779, signed by John Jay on behalf of the Continental Congress, sent to Benjamin Franklin to give to Caron de Beaumarchais. Since Independence Hall is visible from the upper windows of the building where he was speaking, it was a charming touch.

European Central Bank

The European financial system consists of one monetary policy, set by the European Central Bank, but twelve (soon to be twenty-five) fiscal policies, set by the various governments. This was once thought to represent a major difference from the American Federal Reserve, but in fact, it hardly matters. Our fifty component states are not permitted to run deficits, but our federal government runs deficits, plenty of them, and it turns out to make little practical difference if a Central Bank must float bonds to pay for a deficit arriving in one envelope or twelve. What matters is the size of the total. From that starting point, the central bank struggles to modify matters to restrain inflation, or combat unemployment. The main tool at the bank's disposal relates to the fact that governments no longer fear to print more money than they can redeem in gold. They print money, all right, but the spigot is now turned down when inflation begins to appear. In theory, at least, inflation is not possible if the central bank is able to maintain this policy. Of course, if money created in the past comes flooding in from abroad or out of mattresses, there might be a problem. Central bankers seem like terribly powerful people until you count up the people they can't control. The first is the politicians who create those deficits.

European politicians believe their constituents prize security above all else, a condition known as socialism. High taxes, high unemployment, and slow economic growth are considered more tolerable in Europe than sacrificing pensions, health care, and other features of the social safety net; out of this come government deficits, then maybe inflation. The central bank is told to make the best of it.

Then, there is the long-term bond market, which in the past responded to a flood of money by reducing the value of outstanding bonds, which results in higher interest rates.

Euro

Recently, however, long-term interest rates have failed to rise in response to rising deficits, and speculation abounds as to why that should be so. It creates uneasiness to hear that the finances of the world are simply a "conundrum". And finally, foreigners will flee from an inflated currency, eventually triggering a devaluation. A few years ago, Argentina refused to devalue, but the result was a devastating recession when their foreign trading partners refused to deal with an unrealistic currency.

A government which refuses to respond to these "signals" from the bond market and foreigners, will be forced to take some undesirable actions. In Europe, it is to oppose globalization of the economy, thereby hurting everybody but especially poor nations. And the internal European unemployment is shifted as much as possible onto the backs of immigrants, even migrants from within the European community. Take that far enough, and you get serious threats to world peace. Even within the European community, many of the policies which protect the welfare state will consciously injure their own economic growth. Reform is resisted.

Many needed reforms are obvious to policymakers in Europe, and the American example would often seem to be convincing. But it isn't, because Europeans terrified of losing their welfare state recognize that the American model includes a large amount of contempt for socialism, no matter how otherwise successful it is. The interesting thing has been that the Scandinavian countries have an equally extensive welfare safety net, but have nevertheless prospered by adopting free-market reforms. There are signs that this experience is beginning to convince Europeans it is possible to work their way out of the dilemmas.

After his talk, which avoided mention of many of these concerns in the mind of his audience, Governor Noyer was even more charming in cocktail-party mode, but one thing made his face turn beet red. When asked what the John Jay letter was all about, he had to admit he hadn't the foggiest. It was just something hanging on his wall that seemed appropriate for a trip to Philadelphia.

Originally published: Thursday, June 22, 2006; most-recently modified: Thursday, May 16, 2019