Saturday, March 26, 2011

The unnecessary problems of the Euro

European leaders are currently struggling over a package to save the Euro, pouring large amounts of money into funds that should stabilize the fiscal situation in Greece, Portugal, Ireland and potentially other countries. It seems to me that this is a completely unnecessary problem, and all this grief could have easily been avoided with a simple change in policy.

Just look at what is happening in the United States. Several states are in serious financial difficulties and, as several times in the past, California is considering issuing IOUs, thereby essentially declaring it is insolvent. Is there any expectation that other states or the federal government will rush to California's aid because the dollar is threatened? Of course not, despite the fact that California is the largest state in the Union.

It should be the same for the Euro. None of the member countries can monetize its debt on its own, and the only reason that the Euro is threatened is that markets have an expectation that other countries will rush to help, thereby sending a message that monetary policy could be influenced by what is happening in those small countries. And why is this belief well anchored? Because European indeed rush to help (talk about a nice example of self-fulfilling expectations) and because of this silly concept that all national debt in Europe is fungible (talk about a nice example of the tragedy of the commons). Now of course it is a bit late to rectify those beliefs, but had it been clear no rescue package were in sight, those countries would probably not taken such a risky fiscal path in the first place (talk about a nice example of moral hazard). I guess that those silly policy decisions all boil down to European politics, once more (talk about a nice example where economists' advice has been ignored, and they will get blamed for it anyway).

1 comment:

Vilfredo said...

In other words, the Growth and Stability Pact is destabilizing. At least some of the participating countries committed to the Pact with good intentions, but it cannot work if they do not have additional reasons to be careful with their budget.

For another case of a country were the central government has to deal with the shortcomings of the member states in terms of fiscal policy, see the great example of Argentina.