Europe's Great Leap of Faith

Originally published in THE NEW YORK TIMES

January 4, 1999, Monday

Editorial Desk

The euro, the most audacious gamble in the history of currency, has become a reality. What will this crucial step toward unity mean for Europe, the United States and the world? The Op-Ed page asked several experts in economics and observers of European culture to offer their insights.

Martin Feldstein was chairman of the Council of Economic Advisers in the Reagan Administration. [This piece is one of several which appeared in the original "New York Times" article.]

European monetary union is likely to put Europe on a path to higher inflation, reversing 20 years of progress. Before the start of the monetary union, good monetary policy in the major European countries reduced inflation to less than 2 percent because of the dominant leadership of Germany's independent and fiercely anti-inflationary central bank. With the euro, Germany's dominance will end and central-bank independence may be dead.

Even when other countries had double-digit inflation back in the 1980's, public sentiment in Germany supported the tough monetary policies needed to keep inflation low. Under the rules adopted then, other European countries had to follow Germany's lead or accept the destabilizing consequences and political embarrassment of currency devaluations.

But in the new order, the making of monetary policy and therefore the determination of inflation passes from individual national central banks to the new European Central Bank where each country has equal weight. Without the tough standard-setting by the German central bank, the process is likely to drift to higher inflation rates. Indeed, some non-German politicians favored monetary union as a way to end Germany's dominance of European monetary policy, in the mistaken hope that an easier monetary policy would have favorable long-term effects on employment and growth.

Leading European politicians are now also calling for political controls over monetary policy, a clear violation of the Maastricht treaty that established the union and an equally clear recipe for higher inflation. Although the new left-of-center Government in Germany supports this move, the higher inflation that results will be very unpopular in a country in which the majority of voters doubted the advisability of abandoning the German mark for the untried euro.

How Germany responds to the conflict caused by rising inflation will be a critical issue in Europe's political future.