Can a Weak Euro Rescue the Eurozone Economy?

As the Eurozone economy has continued to struggle thus far in 2014, economists have repeatedly called on the European Central Bank (ECB) to take steps aimed at boosting sagging domestic demand and improving the Eurozone’s export competitiveness.  So far, the ECB’s efforts at raising consumer and business demand within the Eurozone have not brought any positive results, as domestic demand in the Eurozone is 5% smaller today than it was in 2008.  As a result, most Eurozone economies are more dependent upon export markets for more of their economic growth than ever before.

Unfortunately for many Eurozone economies, their export competitiveness has continued to decline vis-à-vis their main economic rivals.  This is due in large part to the region’s shrinking labor force, its high costs of doing business and its government-driven inflexibility in many areas.  Moreover, until this past summer, the euro remained significantly over-valued, particularly in the wake of sharp falls in the values of many emerging market currencies over the previous year.  As a result, the Eurozone’s ability to pull out of its long slump was hindered by weak demand at home and a number of competitive weaknesses when competing for export markets.

In recent weeks, most of the economic news from the Eurozone has been quite negative, particularly with regards to domestic demand.  However, one positive development has been the depreciation of the euro against the US dollar and many other global currencies.  This could provide Eurozone economies with a needed boost at a time when the region is in jeopardy of sliding back into another recession.  First, a weaker euro will boost the Eurozone’s export competitiveness at a time when demand in key export markets such as North America is on the rise.  Second, a weaker euro will raise the price of imports into the Eurozone and this could help to prevent a slide into deflation.

A weaker euro will be welcome news for many of the Eurozone’s leading economies.  In particular, those economies that struggle to compete with Germany and other northern European economies for export markets inside Europe will see their prospects outside of Europe improve.  For countries such as Italy, where domestic demand is depressed, this could be the only significant avenue for economic growth in the coming years.  However, Germany is opposed to the euro being allowed to fall much further due to its fears of inflation (despite the near-deflationary situation in the Eurozone) and this could lead to a major clash over monetary policy in the coming months between those who favor a stronger euro and those that need a weaker euro to boost exports.