If Only Someone Had Told The Europeans

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Told them, that is, that disparate economies require different monetary policy to meet the different reactions to economic stimuli:

Is Spain at risk of becoming the eurozone’s next crisis in the making? Angela Merkel’s government fears it could be.
Berlin is said to be growing increasingly concerned that Spain rather than Italy or Greece is now the region’s potential tinderbox.
German officials are worried the economic damage and the political turmoil caused by the country’s Covid setbacks could ripple beyond its borders, according to Bloomberg.
Its virus response has been beset by bitter political infighting, unemployment is rising fast and business surveys suggest the recovery is now back in reverse gear. The capital, Madrid, is facing new restrictions this week that will bring in hospitality curfews and limit gatherings, erupting old faultlines between central and regional governments.

It doesn’t, in fact, matter what those economic stimuli are. Nor whether they are uniform across all the disparate economies yet they react in different ways – as, say, fixed rate and floating rate mortgage systems will in response to a change in interest rates – or whether they face different stimuli just because.

Get a monetary area, a single currency zone, large enough and there will be areas, portions, which react differently at the same time. And those different reactions require different monetary policy to deal with them.

Different monetary policy being just what you cannot have in a single currency zone.

If those Southern countries – Greece, clearly, Italy in slow motion, now Spain – keep having these problems as a result of the system then perhaps it’s the system itself at fault?

Gosh, wouldn’t it be wonderful if we had an area of scientific study which told us about this stuff?

Of course, we do, Robert Mundell’s work on optimal currency areas. Exactly the stuff that the builders of the eurozone insisted upon ignoring for political reasons as they did the building of the disaster.

The proof of all of this not being the current problems. Rather, the property booms in both Spain and Ireland back in the 00s. Then it was Germany that needed the low interest rates as the Hartz labour market reforms hadn’t taken hold as yet. Spain and Ireland needed higher rates to calm the economies. But interest rates in a single currency area will be set for the bulk of the economy, not for the needs of any one part of it nor the periphery. So, interest rates were a tad high for Germany, given its portion of that whole and influence upon the average, and vastly too low for Ireland and Spain.

So, property booms followed, inevitably, by busts. That the euro is a pernicious stupidity was proven 15 years ago that is.

With the current problems, well, if only someone had told them, eh? Or, perhaps, if only they’d listened.

BTW, anyone who is really bored can go look at the archives of sci.econ from the late 1990s. Where they will find my first scribblings upon this ‘ere internet. Which warned of the dangers of a currency area too large to be optimal using the then proposed euro as the type exemplar…..

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Michael van der Riet
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Michael van der Riet

When I discuss this with my Europhile “friends,” they always trip me up with “How does the USA survive then?” I blather my way through with “Each state has considerable latitude in setting its own–” and they interrupt with “The economy of California alone.”

This would be a useful topic for an article? Is California in the Goldilocks Zone for a single currency area?

Spike
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Spike

California has considerable latitude in a lot of things (which it is uniformly doing to ensure self-perpetuation of the current political class), but not monetary policy. Hyperinflation within California is not one of the available tools; if it were, they’d use it, and their target constituency is used to it.

Note that Dollarlandia includes a couple countries in Latin America (and a couple more for purchases such as large appliances).

John B
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John B

The USA has a single fiscal policy and Federal Treasure in which tax receipts from and borrowing for the whole Country is pooled. Money can then be transferred from richer regions or out of borrowing to poorer places. This happens in the UK which has a central Treasury from which poorer regions, like Scotland get money. There is no such pooling of taxes and borrowing in the Eurozone, which has 19 fiscal policies. The Germans are absolutely against their taxes being sent to other Countries or incurring debt to pay for Government spending and top up shortfalls in tax revenues… Read more »

ken
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ken

The US has substantially larger net fiscal transfers. See https://voxeu.org/article/budget-related-cross-border-flows-eu-versus-us Note also that people in America can move more easily due to a common language and shared culture. The scale of movement in the US vs. EU is very large, this then relieves pressure on the states that have been hit by shocks. There are some studies that use European NUTS-2 regions that show movement in Europe is about half that of the US, but NUTS-2 movement mainly shows movement within countries. This one for example: https://voxeu.org/article/labour-mobility-europe-and-us True national level movement is probably less than 20% of the US inter-state… Read more »

jgh
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jgh

Candidly, that wasn’t *real* currency union. It will work next time.

John Galt
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In all seriousness it isn’t. The problems with the Eurozone will continue until transfer payments (i.e. German taxes pay for Greek pensions) are accepted as the necessary price for a federal EU. Even then that will only smooth the shocks, not remove them entirely. For that last part you need to make Germans more Greek and Greeks more German. Can’t see it happening to be quite honest, which comes back to the assessment that the Eurozone will begin to disintegrate as countries like Spain, Portugal and Italy find themselves more likely to succeed outside the zone than within it. Given… Read more »

ken
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ken

John Galt

Ah, but the Euro elites have used the crisis to try to bring in fiscal transfers hence the big covid recovery fund. Which will make a break up more difficult, but also make it less likely. If it does happen it will be messier as a result.
Belgium cannot afford to remain in a strong Euro area and in the event that a messy collapse occurs, the markets will hunt down the weakest members. I’m doubtful about whether France could survive a strong Euro either.

Jim
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Jim

“The problems with the Eurozone will continue until transfer payments (i.e. German taxes pay for Greek pensions) are accepted as the necessary price for a federal EU. Even then that will only smooth the shocks, not remove them entirely. For that last part you need to make Germans more Greek and Greeks more German. Can’t see it happening to be quite honest”

Don’t forget that Angela Merkel is doing her best to turn Germany into somewhere even further south (and east) than Greece………….

Quentin Vole
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Quentin Vole

The Greeks notoriously cooked their books* (with help from the big banks) to pretend to meet the criteria for eurozone membership, This was all very obvious at the time, and I’ve asked German friends why anyone would have believed the Greek figures. “But of course we believed them,” was the reply, “they were Official Government Figures”. Which to a German means they’re holy writ, whereas to a Greek it just means “here are our official figures – and, if you don’t like them, we have others.” Cultural differences (chiefly. but not solely, between north and south) will be the death… Read more »

John Galt
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Cultural differences (chiefly. but not solely, between north and south) will be the death of the EU.

* as also did the French, of course

It was PM Harold Macmillan who said “The French always betray you in the end”. Quite right too.

Spike
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Spike

Whether Covid or simply the desire of gov’t to spend faster than people pay taxes, “monetary policy” means political modifications to the measuring stick. Keynes promised these would be undone “during good times.” If there were ever a time, it was during the two fat years under a businessman President, but Trump too sees that fake money means more factories and a higher Dow Jones. Given that this is the game, what are the right “zones” in which to play it is a silly question. A euro protected against manipulation could have worked in all “zones.” But freedom from rackets… Read more »