Weekend Economists: "So much to do, so little done, such things to be." April 20-22, 2012

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64. Why the Euro Isn't Worth Saving

http://www.theatlantic.com/business/archive/2012/04/why-the-euro-isnt-worth-saving/256006/


Pop quiz, hotshot. You're the prime minister of Spain. It's 2005. Unemployment is at a two-decades low. Housing prices are booming. You're worried that they might be booming too much. You want to put a brake on the economy. You also hope to build up a rainy day fund for any possible bust. How big a budget surplus should you run?

If you've been following the biggest economic debate the past half century, you might think this question is besides the point. Haven't we learned that monetary policy, not fiscal policy, is the best way to manage the economy -- with the possible exception of when short-term rates are at zero? We have. But the irony of Europe is that a defective currency union reverses this logic. When one central bank sets interest rates for different countries with different economic needs and different budgets, it's fiscal policy that matters most. There's no other way to stabilize the economy.

Welcome to life in a suboptimal currency area. After all, countries that share a currency also share monetary policy. If they don't share fiscal policy too -- that is, there is no centralized treasury -- they can get into trouble. Just ask Europe. But as Christian Odendahl at The Economist points out, this also means that each individual country's fiscal policy becomes a much, much more important economic tool than it would otherwise be. Let's think about why this is, and what it says about the future of the euro.

As previously mentioned, monetary policy is usually the first, best, and only policy tool to stabilize the economy. It's quicker and more efficient than government spending. (Anything that cuts out Congress is usually a good idea). But all of that changes when it comes to the ECB. At best, the ECB runs a one-size-fits-one policy. Interest rates make sense for Germany, but not really for anybody else. At worst, the ECB runs a one-size-fits-none policy. Interest rates don't make sense for anybody: They're too low for Germany, but too high for Spain. So, rather than stabilizing the economy, monetary policy actually destabilizes the economy. The booms and busts both get bigger. It's left to each country to use government spending to temper both.