After years of frantic crisis management, European policymakers might be forgiven for feeling somewhat superior as they watch the unfolding drama in the U.S. over the shutdown and debt ceiling. After all, hasn’t Italy just gone from facing the collapse of its government back to relative normality in just a few days?
Perhaps European policymakers have reason for concern, too. Flows into euro-zone assets have lifted stocks and helped them outperform their U.S. peers in recent months – an outperformance that is proving persistent. But they have also lifted the euro. Now, U.S. uncertainty may push the euro higher yet. Indeed, the single currency, around $1.356, is above its 10-year average of $1.327.
The euro’s strength poses a problem for those countries where the recovery remains extremely fragile. Moreover, if it drives inflation yet lower, it reduces nominal growth, meaning debt-to-GDP burdens don’t shrink. The European Central Bank has so far declined to talk down the euro. Euro-zone politicians may do well not to feel too smug.