Andrea Terzi on understanding the EZ dynamic in terms of Germany and France

Under the EMS, French fiscal policy was constrained by the policy of fixing the value of the French franc to the German mark. To make this problem particularly acute, France was pegging its currency to the anchor of a trade surplus country. Pegging your own currency is always a constraint on your fiscal policy. Pegging your currency to an important trading partner, whose growth model is export-driven, can make things particularly bad. Your partner is redirecting demand from your citizens to its firms by taking advantage of a fixed exchange rate, and you need to create demand through net government spending, but this is prevented by the exchange rate peg. It’s a catch-22.

So went the France-Germany asymmetry during the EMS.

France and Germany must have genuinely thought that a common currency would address the asymmetry. Germany, on its turn, was facing the problem of periodic realignment (revaluations) of the peg that made its export industry losing profits. And indeed a solution to the asymmetry could have been an EMU with federal net government spending. This would have spared France the need of creating demand internally, as demand would have been created instead at the ‘federal’ level.
Nothing like this, however, was ever seriously designed. And the bottom line is that France got trapped into the same situation: pegging its money, this time ‘hard’ pegging its money, with an export-led trading partner.

 Mecpoc
A narrow path ahead for Europe: And it’s France and Germany, again
Andrea Terzi