Should we now conclude that the euro is just fine?

No, and that is the topic of my latest Bloomberg column:

The core difficulties of the euro arise when two circumstances coincide: There are deflationary pressures, and economic conditions vary greatly among the nations of the euro zone. The good news is that neither of these circumstances currently prevails. That is also the bad news.

Inflation rates have been high, especially in the euro zone, and are expected to be higher than 9% for December 2022. Inflation brings problems of its own (more about that later), but in the short run it does not lead to huge unemployment and loan defaults. If anything, it helps out some debtors.

During the 2011 crisis, there was massive deflationary pressure on the Greek banking system, endangering its solvency. The Greek government’s deposit guarantees were not entirely credible either, so many people withdrew their deposits, increasing pressure on both the government and the banks. Whatever problems euro zone nations may have today, they are not those.

A second issue in 2011 was that some nations were doing much better than others. Germany had a relatively strong economy, while Greece and Italy’s were relatively weak. Greece, Italy and some of the other “periphery” nations would have preferred a weaker euro, to boost their exports, but the strength of Germany and some of the other more prosperous euro-zone nations limited euro deprecation.

Today, problems in the euro zone are more evenly distributed. Current data indicate a shallow rather than deep recession, but countries such as Germany still face real challenges. The euro, in turn, has been relatively weak, which has limited some of the downside risk faced by the euro-zone economies…

Unfortunately, those mechanisms postpone but do not eliminate the core problems with the euro zone. First, if the zone works better in inflationary times, politicians committed to it will become more attached to higher rates of inflation. That will make it harder for the European Central Bank to achieve its goal of price stability.

And:

The second problem is this: High inflation eventually brings a process of disinflation, and during those disinflations real interest rates are often high. The ECB hikes nominal interest rates, and as inflation diminishes those rates rise in real, inflation-adjusted terms. In other words, some deflationary pressures are brought to bear on the system.

Those deflationary pressures are exactly what the euro zone does not handle well. Italy in particular faces ongoing fiscal problems, and if its government had to borrow at much higher real rates of interest, its current fiscal path may not prove sustainable. It might be forced to cut government spending and/or raise taxes, which would lead to the kind of downward spiral that characterized the earlier euro-zone crisis.

Diverging economic fortunes for euro zone nations may reemerge as well…

So I think people are being a bit too optimistic about Croatia joining the eurozone.