Greg Mankiw wrote a week ago
in the Sunday New York Times, ably explaining the conventional view that the Euro is a bad idea, and that even countries as small as Greece (11 million people) need national currencies. Excerpt:
Monetary union works well in the United States. No economist suggests that New York, New Jersey and Connecticut should each have its own currency, and indeed it would be highly inconvenient if they did. Why can’t Europeans enjoy the conveniences of a common currency?
Two reasons. First, unlike Europe, the United States has a fiscal union in which prosperous regions of the country subsidize less prosperous ones. Second, the United States has fewer barriers to labor mobility than Europe. In the United States, when an economic downturn affects one region, residents can pack up and find jobs elsewhere. In Europe, differences in language and culture make that response less likely.
As a result, Mr. Friedman and Mr. Feldstein contended that the nations of Europe needed a policy tool to deal with national recessions. That tool was a national monetary policy coupled with flexible exchange rates. Rather than heed their counsel, however, Europe adopted a common currency for much of the Continent and threw national monetary policy into the trash bin of history.
Making matters worse, however, was the common currency. In an earlier era, Greece could have devalued the drachma, making its exports more competitive on world markets. Easy monetary policy would have offset some of the pain from tight fiscal policy. Mr. Friedman and Mr. Feldstein were right: The euro has turned into an economic liability that has exacerbated political tensions. For this, the European elites who pushed for the currency union bear some responsibility.
I am a big euro fan. This seems a good moment to explain why I don't accept this conventional view, despite its authority from Milton Friedman to Marty Feldstein and Greg Mankiw and even to Paul Krugman.
Short: I am also a big meter fan. I don't think each country needs its own measure of length, or to shorten it when local clothiers are having trouble and would like to raise cloth prices.
Longer: This conventional view is deeply old-Keynesian. In this view, each region, including ones as small as Greece (11 million) or Ireland (4.6 million), less than the Los Angeles metro area (13 million), suffers "demand" shocks, which governments must actively offset with fiscal stimulus or monetary policy.
This strikes me as one of those many stories that people repeat all the time until they believe it, but whose foundations are seldom examined. (There is a "thesis topic" label here for such examination. Comparisons of US states to European countries on these dimensions seems fruitful.)
What are these local demand shocks for small open economies in the eurozone? "Aggregate demand" is, well, aggregate, not regional. Changing fortunes of local industries is more what we call "supply," not "demand." For small open economies (LA) much "demand" comes from other cities and states, not local.
What is this "fiscal union," apparently providing countercyclical Keynesian stimulus at the right moment? In the US, we have Federal contributions to social programs such as unemployment insurance. Europe has the common agricultural policy and many other subsidies. We do not have systematic, reliably countercyclical, timely, targeted, and temporary local fiscal stimulus programs. Just how big is the local cyclical variation in state or local level government spending or transfers? (And why does fiscal union matter so much anyway? If you're a Keynesian, then local borrow and spend fiscal stimulus should be plenty. The union matters only when countries near sovereign default and can't borrow.)
The local and cyclical qualifiers matter. Yes, both US and Europe have some pretty large cross-subsidies. But most of these are permanent. The rest of the nation subsidizes corn ethanol to Iowa year in and year out. Social security payments come year in and year out, and transfer money from states with workers to those with retirees. Monetary policy has at best short-run effects, so the argument for currency union has to be about local cyclical, recession-related variation in economic fortunes, not permanent transfers.
And Federal fiscal transfers only started in the 1930s. We had a currency union in 1790, and no substantial Federal fiscal transfers at all until the 1930s. How did we get along all this time?
A sense in which this is a centrally old-Keynesian argument is that Greg is not making a second, common, and also wrong (in my view) case for national currencies: the view that currency union demands central bailouts of sovereign debt. No, Greg (and the conventional wisdom he echoes) has in mind only the necessity of Keynesian countercyclical policy. Aphorisms such as "currency union demands fiscal union" are dangerous, as they have many meanings.
So, this conventional view presumes that there really are big regional "demand" shocks; that there is a big, important Keynesian fiscal multiplier, even away from the zero bound, and that our government really does a lot of recession-related fiscal transfers, larger than Europe's (agricultural subsidies, etc.) and that the US pre WWII was a disastrous too-large currency area. I'm not convinced on any of these points.
(To be sure, I will admit a multiplier of about one for state to state transfers. If the federal government takes money from the citizens of New York, and sends the money to people in Florida, businesses will move from New York to Florida to follow the money and GDP will rise in Florida. And decline in New York.)
Consider Greece, "In an earlier era, Greece could have devalued the drachma, making its exports more competitive on world markets. Easy monetary policy would have offset some of the pain from tight fiscal policy." So, Greece's GDP is falling because of "tight fiscal policy?" Calamitous regulation, corruption, closed markets, and now closed banks, frozen payments are not relevant? Tight fiscal policy? Greece is still running primary deficits. After blowing through one and a half GDP's worth of what are now transfers from the rest of the EU, they've run through another half a GDPs' worth, and GDP collapses more. Really, Greece's economic problems are.... a lack of adequate borrowing and spending? And all Greece needs is one more devaluation, and suddenly will be shipping Porsches to Stuttgart in return for worthless pieces of paper rather than the other way around?
Greg passes on the labor mobility story. Here too I'm dubious and curious to see numbers. The story is also told that there is less and less labor mobility in the US, especially of people leaving dying regions. And there are lots of Polish-plumber stories from Europe, that open borders leads to lots of migration. Here again,
cyclical migration, on the scale for which monetary policy can substitute, seems unlikely. How big are business-cycle frequency migration flows across states in the US vs. Europe?
Again, the US until 1933 poses an interesting challenge. Your school stories of westward migration were not a business cycle frequency response to demand shocks. And when people traveled by horse or foot, the vast majority of Americans never moved more than 20 miles from where they were born. The costs of labor mobility in Europe today are vastly smaller than the costs of labor mobility in the US 19th century.
Conversely, and perhaps more centrally, I less trusting of the stabilizing influence of central banks. Dispassionate omniscient central banks can, in theory, wisely spot demand shocks and cleverly devalue currencies to offset them, while not responding to supply shocks, political demands, and so forth. The same technocrats could quietly redefine the meter as needed to let tailors respond to shocks without changing prices.
But the history of small-country central banks is not so reassuring. Grece and Italy's repeated devaluations and inflations did not bring great prosperity.
Joining a common currency is a pre-commitment against bad monetary policy as well as foreswearing of hypothetical good monetary policy. Political forces seldom think there's enough stimulus. When Greece and Italy they joined the euro, they basically said, defaulting and inflating now will be extremely costly. They were rewarded for the precommitment with very low interest rates. They blew the money, and are now facing the high costs they signed up for. But that just shows how real the precommitment was.
Micro, macro and politics interconnect. The case for separate currencies is to protect the economy from sticky wages, sticky prices, and sticky people. But none of these stickinesses are written in stone. A plausible answer to my question about pre-new deal US is that prices and wages were not sticky (whatever that means) before the era of regulation. Well, that is a loss, and only very imperfectly addressed by artful devaluation of the currency. Not every block can have its own currency, so local and industry variation within a country remains hobbled by sticky prices, wages, and people. If sticky wages, prices and people are the central economic problem, we ought to have a lot of policies to unstick them. We do the opposite, and Europe even more so. The very social programs that Greg implicitly praises for fiscal stimulus tie people to location and undermine labor market flexibility.
The strongest case for a separate currency might come from a small economy like Chile, which sells one product (copper), subject to big price fluctuations, and otherwise is pretty closed, and has institutions with sticky nominal wages that it doesn't want to fix. When the price of copper declines, price times marginal product of labor declines, so real wages should decline, and the value of haircuts provided to copper miners should decline as well. Chile may prefer to keep nominal wages steady and let the exchange rate rather than wage rate discourage imports.
But even Chile exports a lot more than copper these days.
Texas is still booming despite a large decline in oil prices. The same argument does not hold for company towns within the US, which do not use their own currency. Stanford has extremely sticky wages (tenure), and suffers "demand" shocks, (positive lately), without offsetting fiscal stimulus and tremendous labor immobility. It takes a year to hire faculty. But nobody thinks Stanford should have its own currency, and periodically devalue that currency. Why not? Because we are open.
So I think a lot of the conventional view seems to think implicitly of fairly closed economies, operating in parallel. But Europe's economies are open. Moreover, the whole point of the eurozone is to open them further. Small
open economies are much worse candidates for their own currency.
Surely each block should not have its own currency, nor each city. We'd probably all agree that very small countries should not -- Luxemburg, say. So the question is really whether the Greece that Greece wants to be -- more open than today -- is effectively of the same size.
So, to sum up, Greg's article very nicely summarizes the conventional view. Recognize that this conventional view is deeply old-school Keynesian, both in its view of fluctuations, the need for constant "demand" management, and the success of "demand" managers to do their job. There is room for disagreement on that theory, and more productively on the underlying facts Greg passes on.
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