Paul Krugman: Can Europe Be Saved?

Krugman's article seemed to be a relatively unbiased summary of an academic area called Optimal Currency Area: http://en.wikipedia.org/wiki/Optimum_currency_area

A "Currency Area" has benefits and drawbacks. The benefits are mostly microeconomic in nature. For instance, if I can contract to buy something from you in the future without having to hedge currency risk or change money, that's a benefit.

The drawbacks are mostly macroeconomic in nature. For instance, Germany is doing OK now while Greece is suffering. However, they share one currency (the euro). If they had two currencies, Greece could devalue its currency, which would boost its economy.

The drawbacks can be mitigated by things like labor mobility, e.g. Greeks fleeing Greece to go to Germany where the economy is better. This happens in the US all the time. However, Greeks and Germans don't share a language, so this limits labor mobility.

Similarly, price/wage flexibility is important, but again, Europe does poorly on this test because its unions and work rules.

Another way to mitigate currency area drawbacks is for the region to have a "transfer union" that can use fiscal policy to spend more money in struggling regions. However, Germans don't like the idea of giving money to profligate Greeks who waste it (this is their view).

All in all, most economists don't think that Europe is an Optimal Currency Area and that weak countries will be kicked out of the Eurozone.

A couple of places where I disagree with Krugman:

...as the earlier Ireland-Nevada comparison shows, the United States works as a currency union in large part precisely because it is also a transfer union, in which states that haven’t gone bust support those that have.

I disagree strongly with his Ireland-Nevada comparison because the US Federal government is currently bailing out homeowners and banks who got into trouble as a result of Federal policy. The fact that the US housing bubble was most severe in California, Florida, and Nevada has little to do with the state and local government policies there and more to do with geography and migration patterns related to demographics. In Europe, the Germans are basically being asked to bail out governments who got into trouble as a result of malfeasance or bad policy that had nothing to do with the German government. Until the Feds start explicitly bailing out states like California or New Jersey (which could certainly still happen), it seems to me as if they are really just bailing out themselves.

Since these bonds (E-bonds) would be guaranteed by the European Union as a whole, they would offer a way for troubled economies to avoid vicious circles of falling confidence and rising borrowing costs.

They would also offer a way for these economies to take advantage of lower interest rates to continue to act irresponsibly, which seems a likely scenario given the history of this situation. Political institutions (and people) being what they are, it seems like extreme amounts of pain is likely to be the only effective tool to get them to actually move away from spendthrift policies. The Euro would probably be in a better position if it came with an explicit requirement that the bonds of member countries could not be purchased by the Union itself or by other Union members, which might have reduced the appetite for the bailout trade that major banks were so happy to engage in (although such guarantees can certainly be circumvented, as the Argentine example shows).

Only read the first page. But, it sounds like a better title would be "Can the Euro Be Saved?"

Like always, mr. Krugman gets it wrong. Of course he blames the single currency, when he should have blamed things like "rules governing worker firing helped limit job loss, while strong social-welfare programs ensured that even the jobless retained their health care and received a basic income.". There's one thing that I've learned as a programmer, there's no silver bullet, you can't have both "strong" social programmes and a dynamic and versatile economy. You can't both stay at home doing nothing for most of the day (look at the 35-hour week in France, for example) and still dream at a life-style consisting of holidays abroad and 2 cars per family.

I really take a bow. This article show why this man has won Nobel Prize. It is really tough to explain such a complicated problem with so easy to digest words.

BTW I am German.