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The Euro
How a Common Currency Threatens the Future of Europe
Joseph E. Stiglitz
read on April 10, 2017

I've understood for a while why the shared EUR currency causes problems for its member states; mainly that monetary policy is restricted to a broad economic region, but that fiscal policy and political realities are localized to individual member states. Meaning, e.g., that Greece can't just inflate its own currency in order to boost its own economy. 

A key thing I'd like to understand after reading this book is: what is the core difference between the EU and the separate states of the USA? Why is the EU barely able to stay together (for now), and the USA has been more or less secure for 250 years? Is it just that the USA is more politically similar? I don't think that's good enough. I want to understand that better on a first principals basis. The USA is basically 50 states with 50 economies and 50 currencies that are all pegged to each other. Detroit can't inflate their currency in bad times to boost the economy...

There are three adjustment mechanisms in the US that don't sufficiently apply in the EU....

  • Ease of migration:
    • English is the common language
    • Assistance programs (medicare, medicaid, social security, SNAP) are federal, and so localized economic downturn within a state is offset by increased federal subsidies in these forms.
    • w/r/t these points, migration in EU is hard. Large linguistic, cultural, and licensing barriers. EU nations also want to preserve these cultures more than US States do. A South Dakotan is an American first, and that identity doesn't change as they move within the US.  "A South Dakotan is not in California as a guest, but as a right. A right, the revocation of which, is unimaginable. There is no distinction between a native Californian, and an immigrant from South Dakota." This is not so in the EU. A Pole in Ireland is still a guest. Most economic assistance programs in the EU are national (not federal), and so during an economic downturn the local Gov needs to subsidize the people via these programs exactly when it can least afford to do so.
  • Banking system is shared. Insolvent banks are bailed out by FDIC (a federal agency). Whereas in EU, banks are federally owned, and a banking downturn is pro-cyclical. Banks will need to be bailed out the most exactly when the gov can least afford to do so. 

Why the EUR is good

  • No FX eliminates FX risk to individual firms and workers. This should encourage investment and movement of capital across borders, to where it is most needed. This principal of economic gravity is generally true, in that, ceteris peribhus, capital-deficient areas provide the highest risk adjusted return, and so absent other frictions capital should flow there naturally.
  • Having a single CCY creates a community mindset amongst member nations. 

Why the EUR, is bad:

  • ECB's mandate is only to monitor inflation. Not to promote economic growth and/or limit unemployment. This single mandate means that's all the ECB technically focuses on, and so it misses opportunities to combat high unemployment amongst member nations.
  • Proponents of the EUR advocate that single economies can experience "internal devaluation". When the local economy falls, unemployment rises, so wages should fall, then prices should fall, since their are fewer customers with disposable income (this would be true even in a fixed ccy). Falling prices would increase exports and naturally help reset the economy, bringing it back to full employment. However, that doesn't happen as easily as predicted, partially due to wage rigidity. For prices to fall, firms need to lower wages, which is tough to do given worker moral. Additionally, local firms are highly unlikely to lower prices during local financial crisis, where they've lost confidence in their local banks. If a business doesn't have faith that it can borrow money in order to stay afloat, then it is highly incentivized to keep as strong a balance sheet as possible (buffer cash), and will be less willing/able to lower prices (than they would be if they had confidence in their banks).
  • EU "convergence criteria", the requierments that must be met in order to join and stay in the EUR, demand austerity at the worst times. In this respect it seems like the EUR leaders have no understanding of macroeconomic history. They're limited in their ability to juice the economy through deficit spending.
    • They are not alone. Clinton republicans tried to pass a constitutional ammendment capping federal deficits. Crazy!
  • EU still has someone onerous barriers to migration, particularly language, though licensing barriers are significant as well. A Spanish person trying to work in Germany is much different than a Floridian trying to get work in Ohio, noted above.
  • While EUR does have the ECB, the banking system in EU is still national, not continental. Banks within the EU are not backed by the ECB, and so are more risky, and more likely to fail when they are most needed. In contrast to USA, where banking system is nationalized. For instance, no specific state could have bailed out the banks in our 2008 crisis - we needed coordinated USG response.
  • EU does not have continental assitance programs, like USA's SS, medicare/medicaid/ snap. Assistance programs are nationalized, another pro-cyclical spend. When the local economy crashes is when spending in these programs is needed the most, but that's exactly when the local gov can least afford to spend here, and they can't run heavy deficits to do so given the convergence criteria, so there is little faith/efficacy with these programs.
  • Key levers in correcting a bad economy are: FX rates, interest rates, fiscal policy. EU nations cannot change FX rates and interest rates. And EUR convergence criteria limits the third option, since member nations must keep fiscal deficits (even temporary ones) to a prescribed minimum.

What can we do to fix it?

  • Stiglitz summarizes this by saying we either need a lot more  EU or a lot less EU. He strongly supports the former, since the EU project overall is a global stabilzer. He lists several reforms that are needed immediately. The most urgent once are expansion of the role of the ECB - giving them a common deposit insurance, and expanding the mandate to cover inflation, employment, and financial stability (like US).
  • Stiglitz has some interesting ideas in terms of how to potentially stabalize the currency from here. He suggests breaking it up into several different currencies (EUR North, South, etc) between more similar countries, and suggest ways to integrate them over the long term, eventually leading back toward a single ccy. 
  • In the end though, the book is pretty pessimistic. It seems like none of the real banking reform is going to happen, and also that the German's are going to remain in charge, and continue to impose non-Keynsian convergence policies,  which is going to continue to destabilize  the weaker EUR nations. This, combined with the anti-globalist populism that's becoming increasingly popular politically, seems like it spells the end for the shared currency. 

Author Bio:

Joseph Eugene Stiglitz (born February 9, 1943) is an American economist and a professor at Columbia University. He is a recipient of the Nobel Memorial Prize in Economic Sciences (2001) and the John Bates Clark Medal (1979). He is a former senior vice president and chief economist of the World Bank and is a former member and chairman of the (US president's) Council of Economic Advisers. He is known for his support of Georgist public finance theory and for his critical view of the management of globalization, of laissez-faire economists (whom he calls "free market fundamentalists"), and of international institutions such as the International Monetary Fund and the World Bank.