Europe has faced many political and social difficulties in recent months: an unexpected rejection of the EU constitution, a troubled and indecisive election in Germany, and political riots in France. To add to their troubles, the European Central Bank (ECB) announced this month that it might have to raise interest rates on the Euro as soon as December.
Inflation is estimated to rise even after the Euro hit a historic low against the dollar this month. At the same time there is no denying that certain sectors of the European economy have been suffering from instability.
Interest rates on the Euro have been maintained at a low 2 percent for the last six years. President of the ECB, Jean-Claude Trichet, declared this month, however, that the ECB will raise rates by a quarter percent.
Wolfgang Munchau of the Financial Times points out that the Maastricht Treaty mandates the ECB focus exclusively on price stability - often at the expense of other policy goals. The dilemma that the European Central Bank faces isn't purely economical, but in fact questions the very existence of the Euro as a unitary currency.
Increasing interest rates will cushion inflation, but it can stunt economic growth in European countries currently experiencing economic bursts. The fundamental problem of a twelve-country monetary union is determining how to adjust policies. While there are many disparate levels of growth and employment, there is only one monetary policy.
Increasing interest rates will push the Euro up against the dollar. For countries that need to grow economically, this will increase their export prices. Businesses already need to come to terms with the high oil prices that are now finally taking a toll. Decreases in exports will only delay economic growth further.
The response to increase interest rates on the Euro has not been met with an equal amount of warmth and appreciation by states in the heart of Europe, many of which are facing negative economic growth and instability.
Consumer prices have increased by 0.5 percent all over Europe this year. Increased oil prices set in dollars are estimated to trigger inflation. Independent from this, inflation is bound to augment in states on the edge of Europe, such as Finland, Spain, Sweden and Ireland that are currently undergoing positive economic growth. Higher interest rates will not only keep the lid on inflation, but have already elevated business confidence for European manufacturers.
Germany - often viewed as the anchor of the European economy - is urging the ECB to keep interest rates low. It is promising to help keep the value of the Euro intact by decreasing the German budget deficit in 2006. Germany has failed to adhere to the EU budget deficit limit of three percent since 2001. To reduce its spending it has begun issuing its government debt in dollars instead of euros. As a new government takes effect, Germany is attempting to recover from its current weak economic state by finding ways to decrease unemployment and by adopting improved fiscal policies. Until stability returns, it is asking the ECB to hold off on increasing interest rates.
France is still suffering from the effects of recent political riots. The riots are thought to have economic underpinnings, caused in large part by expanding unemployment and a floundering economy. France has also expressed the concern that increased interest rates will deter economic growth when it is most vital.
Along with Germany and France, Italy is also lobbying to keep interest rates on the Euro intact. Higher interest rates might impede Italy from meeting its goal of 3 percent GDP growth.
The Euro zone countries are being asked to choose between ameliorating their own domestic economies and saving the Euro zone economy as a whole. The world will have to wait beyond Thursday's decision to determine whether the Euro can unite 12 disparate economies under an effective monetary policy.
