Whither the Euro?

Ivo Daalder offers a thoughtful analysis of the European crisis, including his concerns for the post-Cold War peace we now take for granted. One major factor he does not address is the future of the Euro.

The best clue to what happens next in Europe will be what happens to public support of the Euro and of the common economic policies necessary to support it. The Duke has long held the view that the European currency cart was put far, far ahead of the political horse, and that economic strains would eventually tear the EU's fragile political unity to shreds.

If Ivo is right, then the politics are collapsing first, which is even more ominous.

Successful monetary policy requires a fair bit of independence from political pressures, but it also requires significant political cohesion so that the central bank can set a common interest rate across diverse economic regions. In the 1980s, for example, the Federal Reserve was faced simultaneously with an energy bust in Texas and the Massachusetts Miracle. Liquid labor and capital markets help balance such disparities, but a common political identity gives central bankers additional leeway. The risk for the Euro is that Europe has far less liquidity and political cohesion than most other common currency zones.

The European Central Bank is now facing enormous pressure to cut interest rates. With political support already shaky, it will be enormously difficult for the ECB to balance inflationary concerns in one part of Europe against the need for stimulus in another. A significant economic shock in just one region could further fracture political unity and put both Europe and the Euro into a dangerous downward spiral.