Brussels or Frankfurt? We have a problem

  Just a week earlier, the Bank of Spain had carried out massive interventions (close to 20 billion dollars) to support parity of the peseta in the European Monetary System. But it was not to be. After eleven hours of deliberation, the Monetary Committee decided on a 7% devaluation of the central parity of the peseta putting the exchange rate against the deutschemark at 85.07 pesetas. That was a little after one o’clock on the morning on Monday, March 6, 1995. It was the last devaluation of the peseta because the Spanish currency would be replaced by the euro in 1999. Almost immediately, the Bank of Spain, which only a few months before had been given status as a body independent of the government, raised interest rates in order to dispel inflationary prospects.

  More than ten years later, Spain’s economy is showing strong growth and creating employment but there are some signs of overheating, inflation is systematically higher than in the euro area and, more than anything else, the foreign deficit is headed toward astronomical levels. Up until very recently, the idea that the trade deficit could reach 10% of the gross domestic product in 2006 would have been regarded as ridiculous. Now, it has become a plausible hypothesis. Plausible but difficult for the economic authorities to accept. The classic remedy to halt this trend would be to devaluate the currency or to raise interest rates. But neither one or the other is now possible. Under the rules of the Economic and Monetary Union, decisions on the exchange rate of the euro are adopted in Brussels by the ECOFIN, the Council of Ministers of Economy and Finance. The decisions on interest rates, however, fall to the Governing Council of the European Central Bank which meets in Frankfurt on the first Thursday of each month. Spain scarcely represents 11% of the economy of the Twelve and its problems are nothing like those of the main economies of the euro area. The solution is not going to come from there.

  As we cannot have recourse to traditional remedies we shall have to rely on alternative medicine of slower effect but, if properly applied, this could more adequately cure the sickness as diagnosed. In this respect, the therapy would, on the one hand, involve applying those structural reforms which would make it possible to recover Spain’s lost foreign competitiveness. Or, on the other hand, use could be made of the last instrument for managing demand now left to the government – a budgetary policy which would somewhat relieve the pressure of domestic demand on imports.

  In the matter of competitiveness, the key lies in industry. Whereas construction and services continue full steam ahead, manufacturing companies, which are subject to fierce international competition, are suffering from a situation which does merit greater attention. Situations of relocation and disinvestment are more and more frequent and now involve key sectors such as motor vehicles and components. The market penetration of low-cost imports from emerging countries is taking some economic activities, such as textiles, to a critical point. For this reason, it is necessary to redouble efforts in two directions which are being debated at this very time – strengthening research and development policy and labour reform. It is not possible to save companies which are unable to compete in the globalized world, although it is possible to aid the efforts of more competitive investors and provide them with greater support and a more flexible and efficient environment.

  October 26, 2005

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