Monday, November 23, 2015

Real Effects of the Euro: A Comparative Analysis

Matthew C. Klein has written an excellent paper showing how the euro has failed to bring about the benefits for all that it was supposed to confer to the eurozone members, in 'The Euro as Pointless" in the Financial Times of November 11.

“It’s easy to forget now, but the single currency wasn’t created purely as a political project.
Many economists in the 1980s and 1990s thought monetary union would encourage cross-border investment and trade by eliminating the risk premiums associated with the supposedly destabilising devaluations of the past. The net effect would be converging living standards, dampened business cycles, slower inflation, and faster productivity growth for everyone — the benign Germanisation of Europe.
This was a laudable goal, but unfortunately it’s not how things worked out.”

This is precisely what I showed in my 2002 paper “l’euro, tout ├ętait faux”, an early analysis of that failure here.

Excerpt from Klein’s conclusion:

“In retrospect, it’s clear the euro simply shifted risk from exchange rate fluctuations to defaults (for foreign creditors) and nominal income (for domestic workers and businesses). This wasn’t sufficiently obvious at the time, however, or we wouldn’t have seen such massive growth in cross-border banking and portfolio flows within the currency bloc before 2008.

Contrary to what the euro’s founders believed, it now appears the absence of monetary union is what’s needed to channel capital flows most productively across borders. That’s the real tragedy of the single currency: it was pointless from the start.”

Highly recommended.

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