Weekend Economists' 19th Nervous Breakdown April 6-8, 2012

[Demeter]

18. A Centerless Euro Cannot Hold Kenneth Rogoff

http://www.project-syndicate.org/commentary/a-centerless-euro-cannot-hold

With youth unemployment touching 50% in eurozone countries such as Spain and Greece, is a generation being sacrificed for the sake of a single currency that encompasses too diverse a group of countries to be sustainable? If so, does enlarging the euro’s membership really serve Europe’s apparent goal of maximizing economic integration without necessarily achieving full political union?

The good news is that economic research does have a few things to say about whether Europe should have a single currency. The bad news is that it has become increasingly clear that, at least for large countries, currency areas will be highly unstable unless they follow national borders. At a minimum, currency unions require a confederation with far more centralized power over taxation and other policies than European leaders envision for the eurozone.


...if intra-eurozone mobility were anything like Mundell’s ideal, today we would not be seeing 25% unemployment in Spain while Germany’s unemployment rate is below 7%. Later writers came to recognize that there are other essential criteria for a successful currency union, which are difficult to achieve without deep political integration. Peter Kenen argued in the late 1960’s that without exchange-rate movements as a shock absorber, a currency union requires fiscal transfers as a way to share risk....Some European academics tried to argue that there was no need for US-like fiscal transfers, because any desired degree of risk sharing can, in theory, be achieved through financial markets. This claim was hugely misguided. Financial markets can be fragile, and they provide little capacity for sharing risk related to labor income, which constitutes the largest part of income in any advanced economy.
(FINANCIAL MARKETS CAN BE RIGGED, TOO! DEMETER)...Later, Maurice Obstfeld pointed out that, in addition to fiscal transfers, a currency union needs clearly defined rules for the lender of last resort. Otherwise, bank runs and debt panics will be rampant. Obstfeld had in mind a bailout mechanism for banks, but it is now abundantly clear that one also needs a lender of last resort and a bankruptcy mechanism for states and municipalities.

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European policymakers today often complain that, were it not for the US financial crisis, the eurozone would be doing just fine. Perhaps they are right. But any financial system must be able to withstand shocks, including big ones.


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Kenneth Rogoff, Professor of Economics at Harvard University and recipient of the 2011 Deutsche Bank Prize in Financial Economics, was the chief economist at the International Monetary Fund from 2001