Ireland must live with a euro paradox

IRELAND HAS enjoyed many benefits as a founding member of the single European currency.

At a political level, it has served as an sign of the country's commitment to the European project.

At an economic level, it has accelerated convergence with Europe and has enhanced trade links with the euro area.

The combination of both factors, and the certainty provided by the single currency, has stimulated the flow of foreign direct investment into Ireland.

Moreover, for good or ill, membership of the euro prolonged the economic boom, though changing its character.

The initial weakness of the euro against sterling and the US dollar temporarily masked the decline in Irish price competitiveness in the years after 2000.

Low and falling euro interest rates in the first half of the decade and the easy availability of credit accelerated the domestic consumer spending boom and triggered the housing bubble.

The evolution of the Irish economy over the past decade points to two inherent difficulties that membership of the euro poses for Ireland.

In the first place, Ireland is in the unenviable position of having its two principal trading partners, the UK and the US, outside the euro area.

As a result, changes in the euro's exchange rate against sterling and the dollar can exert a decisive influence on Ireland's price competitiveness. In current conditions, the euro's strength is making life very difficult for Irish exporters to the UK and the US, while Irish enterprises serving the domestic market are struggling to withstand competition from keenly-priced British and US imports.

The real exchange rate, which measures Ireland's nominal trade-weighted exchange rate adjusted for the country's inflationary excesses, is the key measure of Irish price competitiveness. Since Ireland joined the euro, the country's real exchange rate has appreciated by almost one-quarter. This is an indicator of the real loss of competitiveness sustained since Ireland adopted the euro.

Given Ireland's atypical pattern of foreign trade, it is difficult to sustain the case that the euro area constitutes an optimum currency area for Ireland.

In the second place, monetary policy within the euro area necessarily is set on a euro-wide basis. One size is forced to fit all.

Thus, where economic performance in Ireland diverges from the European economic cycle, inappropriate monetary policies are imposed on Ireland.

Such dissonance characterised the first five years of the current decade.

Weak economic performance in the euro area dictated cuts in interest rates, reducing the cost of money to very low levels. The domestic boom in Ireland, built on cheap credit and easy money, called out for a tightening of monetary policy.

But no mechanism existed to deliver the required tightening of policy.

The paradox of the euro for Ireland is that it will be increasingly difficult to live with it in the years ahead - but then, we can't live without it.