Other objections raised were the absence of instruments to respond to any asymmetric shocks, and the European economies’ lack of flexibility and real mobility in the labour force. The conclusion was that the euro would never exist! The facts have disproved this conclusion. But the very same arguments are sometimes deployed to suggest that the euro-area economy contains some inconsistencies that could endanger its prosperity. What can we say, from an economic standpoint, on this very important question? Firstly, that monetary union per se, and wherever it takes place, does not necessarily imply that, at any given point in time, all the participating countries will experience the same rate of inflation or of growth, even though the move to the euro was based on the successful completion of a convergence process. Let us focus, for example, on inflation. Present differentials do not appear to be very large, in comparison with the experience of the United States, a long-established monetary union of comparable size. Data on major cities of the US shows that inflation differentials have been at times very substantial, with divergences of 7 percentage points being recorded in the early 1980s. In the euro area, long-term convergence to a common level of prices gives naturally rise to differences in inflation rates across EMU countries. The convergence of productivity and living standards creates a trend towards price convergence, as a consequence of the commonly known Balassa-Samuelson effect.
The increased globalisation of Islamic finance and its greater integration with the international financial system increases the exposure of the system to contagion effect from such developments. In the dynamics of a financial crisis in the conventional financial system, this would be referred to as the second round effects. The first round effects is when developments within the financial system triggers the financial crisis which in turn impacts the real economy. The second round effects is when the resulting slower growth causes further strain to the financial sector. The experience has shown that when such crisis is not contained, the consequent deterioration in economic conditions results in a worsening of the financial crisis. For this reason, resolution has to take place quickly. For Malaysia, in the 1997-98 crisis, every effort was taken to give attention to financial sector resolution so as to prevent the spiral that could have set in as economic activity became affected by the financial crisis. In this indirect manner, Islamic finance would be affected by such financial turmoil. Slower economic growth and the reduction in the global liquidity would affect those institutions that are heavily reliant on a business model that focuses on real estate and asset finance. Islamic financial institutions would also be exposed to increased inventory risk due to the increased volatility and the reduction in asset prices.