Contra Euro 2/n

The Eurozone is not an optimum currency area. The Euro as such was a bad idea to begin with. Notably, this was the standard view of US economists. The North American argument (originating in Canada) was that a currency should be used in an area within which people are willing to move to get a job. The original argument was that the US dollar zone and Canadian dollar zone were not optimal areas and that Western Canada should have the same currency as the US Pacific coast and Eastern Canada as the US Atlantic coast and great lakes region. The argument made over in the USA was that the current Eurozone was nothing of the kind, since people spoke many different languages in it (also food and culture and not really liking each other all that much),

To me the key article, which decided the question, was (pdf warning) Blanchard and Katz 1992 . They assumed that the USA functions OK with the dollar and ask how it works. The key claim is that it does not work because of convergence of GDP or employment by state. Instead they claim to find permanent shifts in employment in different states combined with temporary differentials in unemployment rates. This is possible, because, in the USA people move to where the jobs are. They speculate (oddly in the case of Blanchard) that Europeans will not be so willing to work using their second language. In fact, European countries have huge persistent differences in unemployment rates.

In a “spectacularly ill-timed.” declaration of victory (other pdf warning) Jonung and Drea 2009 announced that the Americans had been wrong and that the Euro worked fine. The next year there was the Greek debt crisis with contagion to other Eurozone countries and not outside of the Eurozone.

I think what happened is that there was a simple standard economic argument based on then conventional simple economic theory and that subsequent events confirmed the skeptics’ predictions.

Jonung and Drea replied with (yet another pdf warning) The Euro: It Happened, It’s not Reversible, so Make it work which title sure doesn’t sound so confident (I haven’t read the paper but it includes the argument that economic policy should not be based on economic considerations.

“the use of the theory of optimum currency area to evaluate the European plans for a monetary union was a major source of U.S. academic pessimism towards the single currency for it led economists to ignore the political dimension of the European integration process. “

My next post will be about the political dimensions of the adoption of the Euro (and of the associated Stability and Growth Pact). They make the economic consequences of the Euro look fine and dandy.

Oddly, the passage of a few years with a new crisis maybe now or maybe not has lead to the re-emergence of the argument that the Euro is a good thing, not just something which must be handled, because it is not “Reversible”. Europhilia is not a zombie idea.

The alleged economic argument for a common currency is that it would reduce the costs of changing currency. This is an old argument. It is only relevant if one assumes that people use old technology. I spent a month in Italy with my only access to M1 being a US ATM card associated with a US checking account. It worked fine. I didn’t notice the difference between it and the Italian ATM card which I had misplaced.

Earlier, I had spent a month without touching a Euro banknote or coin (paying with the Italian ATM card). After a couple of weeks, I decided that this was a protest against the Stability and Growth Pact, but really I was just too lazy to bother taking out paper currency.

The direct cost of multiple currencies is occasional multiplication. That cost may be as high as a millionth of a cent per transaction.

Now it is very likely that I paid large fees to some bank some how. This is not a problem with multiple currencies. It is a problem with regulating banks (notably debit cards in the Europe and other areas such as the third word and the USA (sorry if I repeat myself) are completely different because Europe strictly regulates swipe fees.

There is also exchange rate risk. That is sort of the point (permanently fixed exchange rates would have all of the disadvantages of a common currency). I think this was a manageable problem within Europe until 1992 when capital controls were eliminated. The system went on without them — for a year, then there was a large highly disruptive last devaluation of the Lira. Pegged exchange rates do not work well without any capital controls. Capital controls are inconsistent with European Unification. Therefore a functioning exchange rate system was disrupted and, from then on, the Euro may have been inevitable.

(quick pop quiz which EU countries do not use the Euro? How much of a barrier is this to the flow of goods, services and people in Europe?).