Is the Weak Euro a Problem? Budgetary Discipline Will Help to Strengthen the Euro

The single currency is under immense pressure from the various debt problems in a number of Eurozone countries, having experienced a considerable drop in value compared to the US dollar in recent weeks. Professor Wolfgang Franz, head of the ZEW Research Group “Growth and Business Cycles“, discusses the impact of a weak euro on the German economy and calls for the Eurozone to undertake strict consolidation measures to stabilise the currency.

Professor Wolfgang Franz gained his doctorate in economics from the University of Mannheim. After being granted the title of professor in 1981, he accepted a post at the University of Mainz. This was followed by positions at the University of Stuttgart, starting in 1984, and at the University of Konstanz from 1989. Since 1997, Franz has been both president of ZEW in Mannheim and an economics professor at the University of Mannheim. In addition, he has led the ZEW Research Group “Growth and Business Cycles” since September 2007. His research primarily focuses on macroeconomics, labour market research and empirical economic research. Since 2003, Franz has been a member of the German Council of Economic Experts, of which he has served as chair since March 2009.

Is the devaluation of the euro a problem for the German economy?

There are winners and losers in this equation. Exporters who conduct their invoicing in dollars rather than euros will see some currency gains, at least in the short term. If the euro continues to devalue over a longer period of time, this will stimulate exports to countries that are not part of the Eurozone. Though over half of our exports go to countries outside of the Eurozone, this potential economic upturn should not be overestimated.

The losers are the importers who do not pay in euro. This not only includes firms who source their preliminary products from outside the Eurozone, but also consumers, who will see the price of petrol or the cost of a holiday to Asia or America go up. This is bad for the economy insofar as the consumption of domestic goods decreases.

Who is to blame for the weak euro?

While it is popular to blame the “evil speculators” on the financial markets, this does not address the root of the problem. The financial markets are a merciless reflection of irresponsible and misguided economic policy, punishing wrong-doers in the form of risk surcharges on interest rates and corrections to the euro exchange rate.

What must Eurozone countries do now to stabilise the euro in the long run?

The Member States need to develop and rapidly implement expedient, radical programmes aimed at reducing the dramatically increasing levels of new debt in their public budgets. The best solution would be for them to agree to a consolidation pact with set spending paths for governments and automatic sanctions in cases of non-compliance. This is similar to the proposals put forward by the German Council of Economic Experts in their annual report for the year 2009/2010.

The governments of the Eurozone countries have just approved a 750-billion-euro bail-out plan for Member States in high levels of debt. Will this bail-out help the euro to recover or is it simply putting off dealing with the underlying problems?

I understand the arguments against the bail-out package. The danger of Europe degenerating into a transfer community should not be underestimated. And Germany will not be able to stop this from happening; we already have enough problems trying to balance our own budget.

The reason I am, with a heavy heart, in favour of the bail-out package is that I think the risks posed by the alternatives are much greater than many opponents of the bail-out realise. In the context of financial market crisis, which we are yet to fully recover from, restructuring the debts of the PIIGS countries could have triggered a crash the likes of which could have dwarfed even the collapse of Lehman Brothers. I say “could have”; we have no way of knowing since it is almost impossible to estimate this kind of hypothetical situation. In addition, we have learned from the financial crisis that ultimately a full bail-out – and not individual actions – is the only way to help the situation, just like here in Germany the Financial Market Stabilisation Act together with the SoFFin, rather than bailing out a single bank such as Hypo Real Estate, helped to calm the situation.

In response to the financial crisis and now the sovereign debt crisis, the ECB has dramatically increased the amount of money in circulation, most recently through the purchase of government bonds from high-debt countries. Could the Eurozone be faced with inflation in the next few years?

I don’t think this is an immediate danger, given that the ECB has, in my opinion, credibly assured us that it will collect this excess liquidity and enact stabilising monetary policy through its bond purchase programme. However, the ECB must be able to stand firm in the face of possible political pressure to go easy when it comes to price stability.