An excellent paper by Kevin O’Rourke (All Souls College, Oxford) in Finance and Development (IMF, March 2014).
Excerpts:
“Historians may wonder how it came to be introduced in the first place.
The euro area economy is in a terrible mess.”
Indeed, the eurozone GDP still 3 percent lower in 2013 than in the first
quarter of 2008 while in the United States it was 6 percent higher, and the
zone unemployment exceeding 12 percent, “are not minor details, blemishing an
otherwise impeccable record, but evidence of a dismal policy failure.
The euro is a bad idea, which was pointed out two decades ago when the
currency was being devised. The currency area is too large and diverse – and
given the need for periodic real exchange rate adjustments, the anti-inflation
mandate of the European Central Bank (ECB) is too restrictive. Labor mobility
between member countries is too limited to make migration from bust to boom
regions a viable adjustment option. And there are virtually no fiscal
mechanisms to transfer resources across regions in the event of shocks that hit
part of the currency area harder than others.
All these difficulties were properly pinpointed by traditional optimal
currency area theory.”
Readers please note: it was “the theory” that predicted these
difficulties before the fact, not individual economists! So judgment and clear
understanding of theory and facts count for nothing … What about the (majority
of) economists who neglected the teachings of OCA theory?
Maybe this curious conception of economic analysis has something to do
with the author’s confession, later in the paper, that:
“I and many others have made such arguments (for “more Europe” rather
than less) over the past five years. But as time goes on, it becomes more and
more difficult to do so with conviction.”
His confession of guilt is welcome. But he could add the few names
(there weren’t many!) of the economists who were right from the start, Martin Feldstein for example. And one
that, spectacularly, had his theory right from the start but his analysis dead
wrong, Robert Mundell!
Fortunately O’Rourke has some interesting things to add:
“..it is becoming increasingly clear that a meaningful banking union,
let alone a fiscal union or a safe euro area asset, is not coming anytime soon.
For years economists have argued that Europe must make up its mind: move in a
more federal direction, as seems required by the logic of a single currency, or
move backward? It is now 2014: at what stage do we conclude that Europe has
indeed made up its mind, and that a deeper union is off the table? The longer
this crisis continues, the greater the anti-European political backlash will
be, and understandably so: waiting will not help the federalists. We should
give the new German government a few months to surprise us all, and when it
doesn’t, draw the logical conclusion. With forward movement excluded, retreat
from the EMU may become both inevitable and desirable.”
O’Rourke however relapses in “eurospeak” when he concludes that the
demise of the euro “would be a major crisis” and would require “capital
controls, default in several countries, (and) measures to deal with the ensuing
financial crisis.”
This standard pessimistic outlook has been repeatedly made by euro sectarians,
including Barry Eichengreen who has even claimed that while it was possible to
become a member of the Eurozone, it was radically impossible to get out
(despite abundant contrary evidence on a number of exits from fixed exchange
rates arrangements, as well as currency zone dissolutions) because it would
create “the mother of all financial crises” – whatever that means!
Common sense, on the contrary, tells us that if the real exchange rates
are deeply misaligned within the shared currency (because of implied nominal
exchange rates fixed “forever”) and since the misaligned exchange rates are the
cause of deep structural imbalances in the national economies of the area, a
return to equilibrium exchange rates should favor a resumption of growth an
prosperity. Once this burdensome handicap is removed, the economy should return to
a “natural rate of growth”, especially so because of the accumulated slowdowns of
the past two decades.
A final interesting consideration. Since our techno-monetaro-economists
are so deeply ignorant of political realities and public choice theory, they
should read the following sentence of O’Rourke:
“During the interwar period, voters flocked to political parties that
promised to tame the market and make it serve the interests of ordinary people
rather tha the other way around. Where Democratic parties, such as Sweden’s
Social Democrats, offered these policies, they reaped the electoral reward.
Where Democrats allowed themselves to be constrained by golden fetters and an
ideology of austerity, as in Germany, voters eventually abandoned them.”
Politicians beware ...
