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Do not blame the euro simply because it’s there

Do not blame the euro simply because it’s there

February 17
05:46 2017


The most backhanded compliment you can achieve is to be blamed or credited for anything good or bad that happens when you happen to be around. It’s a fate often suffered by the euro. This month, Free Lunch has noticed a few such cases and would like to offer a fairer interpretation.

A new academic paper on fiscal austerity after the global financial crisis is interpreted by Matt O’Brien at the Washington Post as showing that “the euro really has been a doomsday device for turning recessions into depressions”. But here is what Christopher House, Christian Proebsting, and Linda Tesar, who wrote the (excellent) paper, actually say: “The negative relationship between austerity in government purchases and GDP . . . holds for countries with fixed exchange rates as well as those with flexible exchange rates.” In other words, not specific to the euro. Indeed the country with the best growth performance in their sample is Lithuania — which had dramatic austerity, a large fall in output, but the fastest recovery of the 29 countries (all European, plus the US).

The main finding of the research is hugely important: it is that countries could have had significantly faster growth and greater incomes if they had imposed less austerity — to the point that their debt burdens would have been lighter. As we have insisted before, it is easy to show arithmetically that cutting deficits too fast can make debt problems worse rather than better — and what House and colleagues demonstrate is that this seems to have been the case in practice. But that is the opposite of an indictment against the euro. It rather exonerates the single currency from blame for the disastrous growth experience of many eurozone countries — because that disaster was caused by unforced policy choices by leaders, to which alternatives existed. This study is aligned with previous studies that show how much better eurozone economies could have fared with better policies that were at hand, but tragically left unused.

My colleague Matthew Klein, too, is eager to blame the euro for the woes of its member countries, or at least for Greece. He observes that the Greek crisis experience is one of the worst in history — worse than the Great Depression in the US. He thinks that this observation implies that Greece should have left the euro long ago. We have refuted the common post hoc ergo propter hoc fallacy about the single currency before — the notion that because eurozone economic performance is poor, the poor performance is due to the euro — but it is worth dwelling on Klein’s argument.

It is essentially comparative. The fact that the US could reflate after leaving the gold standard in the 1930s is thought to show Greece’s euro membership to be an obstacle to growth. In a follow-up post, Klein compares the Greek depression to the post-financial crisis performance of five emerging markets that let their currencies float: Argentina, Brazil, Indonesia, Thailand and Turkey. He correctly observes that those countries had milder busts and quicker recoveries (and indeed had stronger booms before their crises). What can we conclude from this about the role of euro membership in Greece’s crisis?

Nothing really. There are plenty of other differences between Greece and Klein’s handpicked sample, in particular the much higher level of public debt. And you can easily pick another sample of crisis economies that didn’t float — such as Bulgaria and the Baltic countries (note the Lithuania finding in the paper mentioned above) — which also performed much better than Greece. Klein himself refers us to a paper by Pierre-Olivier Gourinchas, Thomas Philippon and Dimitri Vayanos, which establishes that Greece did much worse than a broad sample of fixed-exchange rate countries, including those in the eurozone.

What went wrong, then? Klein’s attention to the US in the 1930s is useful, because it helps to pinpoint the things that policy got right then. Surely the banking reform as well as the big spending programmes under the New Deal had a lot to do with the recovery — as the eurozone’s excessive austerity and failure to restructure banks have to do with the weak recovery now. But what was the effect of changing the value of the dollar? Above all, the reduction in the real value of the debts accumulated in the 1920s. But debt writedowns are perfectly doable within the eurozone. Indeed they have been done — for sovereign debt in 2012 and senior banking debt in 2013 — although too little or too late.

The core mistake in eurozone economic policy was the unwillingness to restructure debts in 2010. Doing so then would have removed uncertainty, alleviated the push for austerity and loosened financial conditions by cleaning up bank balance sheets. If any country had left the euro, this restructuring would have been unavoidable. But it would have been the writedown, not the monetary divorce, that would have produced the result. And so it’s not monetary union, but the irrational sanctification of debt by all its leaders, that is at the root of Greece’s problem.

Other readables

  • IMF researchers decompose the slowdown in international trade into its various causes, and find that it mostly reflects sluggish demand growth around the world.
  • The good, the bad and the bubbly: the Bank Underground blog finds that whether cross-border finance does more good than bad depends on whether it takes the form of debt or equity, who is doing the financing and in which currency. Above all, policies can make a difference.

Numbers news

  • It’s a seigniorage bonanza for the European Central Bank, which made a profit of €1.2bn last year on the securities it has bought with the money it prints.

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