The individual countries differ substantially in industrial composition and in a variety of economic policies that cause their cyclical conditions to differ. In 1999, demand conditions in Germany and Italy were relatively weak while demand conditions in Spain, Portugal and Ireland were very strong. The result was a substantial acceleration of inflation in both Spain and Ireland that threatens their competitiveness and therefore the longer term success of the industries that have helped them prosper in recent years. As Robert Mundell taught us many years ago, a single currency is appropriate in an area where labor and product markets are flexible, where labor is mobile among regions within the area, and where a central fiscal authority automatically provides counterbalancing fiscal transfers. These conditions are satisfied in the United States but not in Europe.
European wages are very inflexible.
Labor's mobility is severely limited by barriers of language and custom even if legal barriers are no longer present. And there is no significant offsetting fiscal transfer to compare to the roughly 40 percent offset that US taxes and transfers achieve. This in turn is likely to mean making the monetary policy that is appropriate for Germany, France and Italy. In 1999 that meant a policy that was too expansionary for Spain, Portugal and Ireland. The OECD has warned these countries that they are allowing demand to grow too rapidly.