The Birth of the Euro (review)

In this book, Otmar Issing describes the birth of the euro and its performance through 2007. The author is singularly well placed to tell the tale. As a member of the board and council of Deutsche Bundesbank from 1990 through 1998, he was party to the discussions leading up to the creation of the new European currency. Then as the European Central Bank’s (ECB) founding chief economist and member of its Executive Board, he was intimately involved in developing its policy framework.

Issing thus provides an authoritative account of the Maastricht process, the statute and structure of the ECB, its conduct of monetary policy, and the relationship between Europe’s central bank and the larger integration project. He does this with admirable clarity, betraying his earlier incarnation as an academic. His account is infused by the distinctive German sensibility that places price stability above all other goals of economic policy. Central banks and the societies in whose service they labor may aspire to greater things, but without price stability, there is nothing.

Evaluated on this basis, the ECB’s record through 2007 was good. It succeeded in maintaining low and stable inflation. Consistent with the author’s worldview, price stability was accompanied by economic stability. But eternal vigilance is required. The ECB must continue to wage its righteous war against those inclined toward more inflationary policies, Issing repeatedly warns.

While it is not entirely fair, it is irresistible to ask whether the author would have offered a different assessment had he known of the events of 2010. Early that year, the markets awoke to problems of over-indebtedness and inadequate international competitiveness in Southern Europe. The Greek government was pushed to the brink of default, a fate that it escaped, at least temporarily, with the help of a $125 billion loan from its European partners and the IMF. To prevent the crisis from spreading, the ECB was forced to engage in extraordinary bond purchases, and the EU assembled a $1 trillion rescue fund. Even this did not dispatch talk that the euro zone might break apart, either because a Southern European country desperate to restore its competitiveness reintroduced its national currency or because Germany, concerned that the euro area was turning into an inflationist “transfer union,” opted to leave. The implication, increasingly voiced, was that the euro had been a mistake.

Of course, there is less than full agreement on the precise nature of the mistake. Some say that it was the decision in 1998 to go for a monetary union encompassing not just Germany, France, and their Northern European neighbors but also Italy, Spain, Portugal, and Ireland. Others will say it was the even more dubious decision to admit Greece in 2001.

Still others blame not one country or another but the problematic nature of a one-size-fits-all monetary policy. After 1999, precisely because its interest rates came down to German levels as a result of the euro, Southern Europe went on a borrowing binge. Firms enjoying strong domestic demand felt free to accede to pressure for increased wages. Problems of excessive debt and inadequate competitiveness followed directly. Had they retained their own currencies, these countries could have had a level of interest rates appropriate to their national circumstances, restraining demand. And had they still succumbed to excess, they would have felt the discipline of the market more quickly since their national exchange rates would have dropped. It was the euro, an intrinsically flawed concept, that disabled these corrective mechanisms.

Having completed his book before the crisis, Issing does not speak directly to this controversy. But his account does feature a number of passages relevant to subsequent events. He warns that a single level of interest rates will be tolerable only if governments adjust their other policies to national circumstances. Specifically, countries for which the interest rate is uncomfortably low, encouraging spending, had better tighten fiscal policy to restrain demand. Unfortunately for this argument, the political reality is that it...