Deflation is not the threat it once seemed. Jobs are being created. House prices are rising, confidence is up, and the eurozone's stockmarkets were among the world's strongest in 2015's first quarter. Indeed, the eurozone, which has for much of the last three years limped from one recession to another, is looking a lot brighter. The business cycle has picked up, while lower oil prices and a cheaper currency are kickstarting a moribund economy.
Yet, under the bonnet, things are getting worse. The most fundamental test of the viability of a single currency area is the extent to which its members' business cycles are synchronised. Yet the latest research suggests that Europe is going backwards on this measure. That can only mean more trouble ahead.
Brown's smartest decision
Those of us with long memories will recall that, for much of the 1990s (when, hard as it is to believe now, some people with normal IQs thought that Britain should join the euro), there was lots of talk about whether, or when, our business cycle would be sufficiently in line with the rest of the continent to make it safe to sign up. That was one reason potential members were required to join the exchange-rate mechanism first, so the ups and downs of the business cycle could be aligned. Indeed, our failure to do so was one of the reasons that Gordon Brown (as chancellor) gave for squashing the faint prospect of our joining.
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Given all that, you might expect the nations who did sign up for the euro, and have now been inside for a decade and a half, to have cycles that were gradually coming into line with one another. But you'd be wrong. At the Royal Economic Society conference last week, Brigitte Granville and Sana Hussain presented a paper that looked at how synchronised the business cycles of the main eurozone nations had been for the last 50 years. The short answer? Not much. For most of the time between 1960 and 2013 there was relatively little synchronisation. Greece, Spain and Portugal were among the least in line, while France and Belgium were more so. But overall, there was little evidence they were in step.
Europe's cycles have not synchronised
Still, you might hope they would be moving in the right direction. In the 1960s, with different currency regimes and lower levels of trade, you might see relatively little synchronisation. But you'd think it would grow when they all had the same currency and interest rates, and lower barriers to trade. But no. Instead, synchronisation has actually fallen since the euro was created. In other words, the main eurozone economies are even less like one another now than before 2000.
We can see much the same thing from day-to-day experience. Leading up to the crisis, Spain boomed while Italy stagnated. Greece and Ireland roared ahead, while the core countries grew only modestly. In the last few years, much of the periphery has been through a savage recession, while Germany has been just fine. Now the Spanish have what looks like a healthy recovery, while France has slumped back to zero growth. So far there is no sign of economic conditions in Helsinki being roughly the same as in Lisbon. Instead, there are just wild booms and busts in different regions. The only consistent country appears to be Italy, which has replaced the business cycle with permanent depression.
The Germans don't need QE
That matters. Unless business cycles are roughly synchronised, a single monetary policy will never work. The European Central Bank (ECB) has to set interest rates for the whole eurozone. Unless the cycles are roughly in line, monetary policy will stoke booms in some countries, and busts in others. Would anyone launch quantitative easing (QE) for Germany, where growth is perfectly respectable, and the huge trade surplus already suggests it has an undervalued currency? Probably not. But the ECB has been forced to act because of the crisis across the periphery. Indeed, the surge in German house prices Berlin prices are up almost up 50% since 2010 suggests it may well be stoking the next bubble in that country (which will make the financially sober Germans even more exasperated with the currency).
Likewise, when the ECB finally ends QE, there are bound to be two or three countries for which that is a disaster,triggering steep falls in asset prices, and starting a recession. Even within the UK it is hard to run a one-size-fits-all monetary policy our rates have been too low for London, but too high for Wales. With the eurozone, it was impossible to start with, and has grown harder. There are always day-to-day dramas in the eurozone. The Greeks are usually threatening to default on some payment or other. A bank in Austria or Cyprus is often on the edge of bankruptcy. A far left or right party is rising to power, promising to torpedo the whole project, and the Bundesbank is more often than not threatening to withdraw its support.
But that's all just noise. What counts is whether Europe's fundamental structures are getting better or worse. Right now, they're getting worse and look set to keep doing so. On this most basic measure, the eurozone is sinking deeper into trouble. Sooner or later, that will mean its demise.
