Since the launch of the euro in 1999, economists have debated whether a “one-size-fits-all” monetary policy can work for so many economies; Estonia’s entry from January will take eurozone membership to 17 countries. The answer given by Jean-Claude Trichet, European Central Bank, has always been: mais bien sûr! Eurozone growth and inflation divergences are no greater than between US state, he argues. But life is not as simple as that in the eurozone.
Barclays Capital has just published an extensive review of divergences in growth rates, inflation and labour markets (looking also at the persistence of divergences). It finds something to support both sides of the argument. Eurozone growth rates, for instance, have converged – although the process may have gone into reverse as a result of the credit and construction booms and busts in Spain and Ireland. Divergences in eurozone labour markets, however, are greater in the US.
What makes the study interesting is that Barclays Capital then goes on to calculate what would be the appropriate interest rates for the 11 largest eurozone countries – using the so-called “Taylor rule” by which interest rates are set according to the inflation rate and “output gap” (roughly, the amount of slack in the economy). The report finds a much greater variation than would be the case for the 11 biggest US states. The reasons
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