Don’t Blame the Euro

John Cochrane writes,

It is a new proposition in monetary economics to me that adopting a common currency forces countries to move to common productivity, any more than adopting the meter forces countries to do so. Alabama and California share a currency and not productivity. Fresno and Palo Alto share a currency and not productivity. A common market in products with free movement of capital and labor might force out economic, legal, and regulatory inefficiency, but that would happen regardless of the units of measurement.

I had a brief chat with Cochrane a few weeks ago, and he lamented Milton Friedman’s monetarist influence. Macroeconomists under the influence of Friedman will tell you that a national currency with a flexible exchange rate is a great thing, because you can get more inflation when you need it. The conservative macroeconomists will tell you that the inflation comes naturally from depreciation in the currency markets. Liberal economists will tell you that the inflation comes from central bank manipulation of the money supply.

Cochrane is quite skeptical. His focus is on real factors, not monetary factors.

I agree. In terms of skepticism about monetarism, I take second place to no one. I believe that the euro has microeconomic benefits (transactions are more efficient), not macroeconomic costs.

10 thoughts on “Don’t Blame the Euro

  1. How about monetarism with respect to the narrow issue of sticky wages? Suppose it is a widespread cognitive bias across all people that wage cuts are unacceptable. Being able to delude everyone they are getting a slight nominal raise rather than a real pay cut seems like a useful thing. This seems a lot more efficient than firms that are paying too much going out of business to be replaced by new firms that offer less pay

  2. Indeed. The problem with Europe is not the Euro. It’s the constellation of facts on the ground: Greece overlevered and fails to collect taxes, Spanish homebuyers overlevered (like Americans), the French diigiste labor system (not a market) is stifling, etc., etc. I forecast that Britain will thrive after Brexit and having its own currency, monetary policy, fiscal policy and authority over its own economic rules of the road.

  3. 1. Does the problem of the “optimal currency area” have a solution of “anything”, or perhaps even “everything” for transaction-cost minimization?

    2. A common narrative is that the Euro enabled creditor moral hazard with regard to lending to the PIGS. That is, because of the Euro, the debts were denominated in a hard currency outside the control of unreliable local political systems. Part of the deal of joining the Euro was also a requirement that those countries would maintain tight fiscal discipline. Foreign banks were then convinced that they would be paid back in a hard, stable currency, and that, were anything to go awry with the ability of those countries to pay their debts, the Union would bail them out, one way or another.

    The story continues that if those countries had not joined the Euro, creditors would have imposed much more discipline upon them, and access to foreign capital would have been much more constraining. Local beasts would have starved somewhere earlier on the ‘reckless largesse’ curve instead of politicians being enabled to let the good times roll for a decade longer than they ought to have.

    It’s an open question on whether creditors to various large and politically influential US state and local borrowers can also rely on bailouts should the worse come to pass. If Chicago, California, or New Jersey go bust and big investment firms wobble, will Washington hold the line or piss its pants?

    • This, Handle. We just recently have read about the pseudo-bankruptcy law “Promesa,” under which Puerto Rico has filed suit for relief from its overwhelming debt burden that’s resulted from its own mis-management.
      The likelihood of debt-ridden states like California and Illinois pressuring Congress for bailouts, a la Puerto Rico, is high.

      I’d bet on smelly wet pants, except that it could very well lead to 1/2 the country voting to secede from the Union. /being facetious
      Or, maybe, voting for the expulsion of California and Illinois.

      https://www.usatoday.com/story/money/2017/05/04/puerto-rico-bankruptcy/101284402/

  4. Depreciation in currency markets being called a real factor is amusing.

  5. I agree. In terms of skepticism about monetarism, I take second place to no one. I believe that the euro has microeconomic benefits (transactions are more efficient), not macroeconomic costs.

    If they had a different currency would have Greece depression been as big and great? Or Spain? It strikes me the Euro currency made the rise too high and thus the bottom to low. The movement of people makes a significant impact.

    Anyway, in terms of inflation, I increasingly believe it has nothing to monetary reality. Look at the 1970 versus today, It appears to a demographic reality of high inflation in teh 1970s the population bubble of the Boomers increasing both AS-AD curves and today doing the opposite.

  6. As a value investing fan, I believe in nominal inefficiencies. But I am certainly skeptical of “monetarist destiny.”

  7. Don’t blame the Euro is correct – blame the German inability to understand monetary policy. It was the German belief in a ‘strong currency’ which led to the mess over there. The method by which one achieves a ‘strong currency’ is to under print the amount of new money required every year. I remember the ‘value’ of the Euro soaring, and our COLA getting cut rather drastically.
    Sorry folks – AD matters, and AD is controlled by the central bank. And if anyone wants to try and make some money, the Euro isn’t fixed because it isn’t ‘fixable.’ The US supported the European banks in 2008 by lending them dollars, as those banks didn’t want to hold Euros, leading to a dollar shortage in the wholesale market. I believe Yellen has said we won’t do that again.

    • “Under print” for which economy? It sounds like mainly you’re making the case for different countries with different fiscal policies and different spending habits having different currencies and therefore different monetary policies. Which sounds self evident to me but unfortunately is considered politically unacceptable to many Europeans.

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