Lack of Cyclical Convergence Puts Euro Area at Risk

After 10 years of EMU and a largely positive outcome the global financial crisis will put the euro area to a serious test. Indeed, the euro and the political adjustment processes it entails have already led to the emergence of a European business cycle. As its perfect harmonisation has not yet been achieved and will remain an illusion, drastic events, such as the current shock of a financial crisis, force fiscal and monetary policy makers to react flexibly. Due to the lack of other mechanisms, such as fiscal federalism in the USA, to cushion severe shocks a more systematic coordination of all fields of economic policy and an enhanced cooperation between member countries and the ECB seem highly advisable. The problems resulting from the financial crisis will not be limited to the euro area, but will equally hit the UK, Switzerland and, above all, the USA. At the same time the euro has become ever more important as an instrument for the diversification of world foreign reserves and for this reason alone it is indispensable for the world economy. Admittedly, the current financial crisis has revealed some institutional shortcomings (the unresolved issue of the role of the "lender of last resort"; to what extent will the "no bail-out rule" be applied in an emergency). However, recent experience with the positive interplay of policy institutions has shown that despite various prophecies of doom the viability of the euro area is beyond doubt.