The Causes of Euro Instability

This paper examines the causes of the general decline in the value of the euro. First, it assesses the various explanations proffered in existing literature, and then it offers a more satisfactory one. The argument prevalent in the literature that the decline in value of the euro is due to “US strength” rather than to any inherent difficulties with its imposition is viewed as somewhat undeveloped. We suggest that US strength is an important but only partial factor in the euro’s decline; the other side of US strength is Eurozone weakness. We review the (poor) performance of the ECB and assess the level of macroeconomic convergence of Eurozone countries. We conclude that a combination of Eurozone weakness, endogenous to the inception of the euro, and US strength is the most plausible explanation for the euro’s decline in value. We find that although the future value of the euro is uncertain, the prospects for the eurozone will remain bleak as long as the current institutions underpinning the euro, with their inherent tendencies to promote deflation, are in place.