As euro zone expands, tensions remain between stronger, weaker economies

Jan. 3 (Bloomberg) -- Bloomberg's Elliott Gotkine reports on the impact of austerity measures on 2011 tax rates and public sector wages as European efforts to cut budget deficits begin to take effect.
Washington Post Staff Writer
Wednesday, January 5, 2011; 10:25 PM

German deficit hawks gained an ally Saturday when Estonia became the 17th member of the euro zone, but the presence of euros in Baltic vending machines doesn't mean that the currency zone's challenges have eased this year, analysts said.

Tiny Estonia is the euro zone's poorest nation, and its leaders are likely to be leery of bailing out bigger, richer European countries. Its finance minister, Jurgen Ligi, said this week that he preferred budget austerity to borrowing as a remedy for economic ills.

The tensions between countries with growing economies, such as Estonia and Germany, and countries such as Ireland and Greece, which are bordering on insolvency, are expected to grow as European leaders attempt to come up with a single fiscal policy that works for all nations, analysts said.

The European Central Bank announced Tuesday that December's consumer prices were 2.2 percent higher than 12 months before, the highest inflation rate since October 2008 and above the bank's target of 2 percent.

The news probably will exacerbate the tug of war between the two European factions over how to handle economically and fiscally troubled nations.

In 2011, "we will simply see a continuation of last year's story, which is that the divergence continues," said Carsten Brzeski, a Brussels-based senior economist at ING Bank.

"Germany is powering ahead," he said, while Portugal, Spain, Ireland and Greece "will really lag behind. There won't be any consumption, and there won't be any investment" in the latter nations.

For now, Brzeski said, the central bank is likely to keep interest rates low because it sees economic recovery on the European periphery as more fragile than the strong growth in its core. But he said that he expected the central bank would raise interest rates later this year or early in 2012.

The divides in recovery remain deep and will probably to remain so for years, according to projections from the Paris-based Organization for Economic Cooperation and Development. Almost 20 percent of Spanish workers were unemployed in 2010, and the rate will still be 17.2 percent in 2012, according to OECD figures.

In Germany, Europe's largest economy, the OECD estimated that unemployment was 6.9 percent in 2010 and would fall to 6.2 percent in 2012. In other countries, such as Austria and the Netherlands, the figure is even lower.

One analyst said European economies would simply have to learn to live with the tension.

"The euro zone is not an optimal currency zone, nor will it ever be, so you're going to have these asymmetric shocks" with some economies going up and others going down, even as they are forced to share the same monetary policy, said Jacob Funk Kierkegaard, a research fellow at the Peterson Institute for International Economics.

But European leaders will probably speak in ways that are less likely to upset jittery markets, he said. German Chancellor Angela Merkel and European Council President Herman Van Rompuy learned their lessons in November, Kierkegaard said, when many blamed their statements - Merkel said that private investors needed to be on the hook if countries default on debts, and Van Rompuy said the euro was in a "survival crisis" - for heightening Ireland's need for a bailout.

Since then, Merkel has given several speeches asserting her commitment to the euro and to European economic and political integration.

Analysts said that Estonia was not likely take an assertive policymaking role in the European Central Bank - in which each euro-zone country has one vote and decisions are made by a simple majority - but that its central bank governor, Andres Lipstok, would probably line up behind Germany.

"Estonia's introduction of the euro is symbolically very important for the E.U.," said Wolfgang Reinecke, the director of the Global Public Policy Institute, a Berlin think tank. "Economically, it's negligible" to the euro zone as a whole, he said.

Still, Estonian leaders were eager to adopt the euro. The move had political significance, pulling the nation ever more firmly toward Western Europe just 20 years after it gained independence from the Soviet Union. It also offered economic advantages domestically, eliminating a barrier to trade and investment caused by the need to change euros into kroons, Estonia's old currency.

Other countries, including Poland, Latvia and Lithuania, are expected to follow Estonia into the currency union in the coming years, though all are cautious about joining too soon and none is likely to do so before 2015.

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