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How to restore sustainability of the euro?

Author

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  • Kari E.O. Alho

Abstract

We specify an open-economy version of a two-region New Keynesian model for EMU and demonstrate that the result on the unsustainability of the euro with ever-mounting inflation differentials by Wickens (2007) does not hold in general. Strong fiscal consolidation and far-reaching successful structural reforms are needed to reach sustainability in terms of competitiveness and reduced public debt over the medium run. However, the current deflationary adjustment involves a major polarisation within the euro area. Debt relief within the union and internal devaluation in the debtor country may essentially alleviate the adjustment burden and shift it from the problem countries to the strong countries. An internal revaluation in the strong countries can markedly help the situation in the weak countries in the short run if the interest rate remains unchanged. JEL Classification: E43, E52, E62.

Suggested Citation

  • Kari E.O. Alho, 2013. "How to restore sustainability of the euro?," Revue de l'OFCE, Presses de Sciences-Po, vol. 0(1), pages 303-340.
    • Handle: RePEc:cai:reofsp:reof_127_0303
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    Cited by:

    1. Alho, Kari E.O., 2015. "Structural Reforms and Stabilization Policies in the Euro Area," ETLA Working Papers 31, The Research Institute of the Finnish Economy.

    More about this item

    Keywords

    EMU; euro; sustainability; fiscal policy; competitiveness;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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