There have been some interesting and rather useful exchanges on this blog on the issue of the survival of the single currency in Europe. Well, with EURUSD on its way to 1.40, we do not know if the survival question is better posed to Americans on their currency. Of course, a strong Euro may be a problem for the Eurozone. But, then, there are lags and lags and we do not know when and if there would be a day of reckoning for the Eurozone or the single currency. In any case, that is what we discussed in this post. Thoughts stirred by the comments by Anindya Mitra also led to this sequel article by Yours Truly in MINT.
While searching for articles by Luigi Zingales in voxeu.org, I came across a very thoughtful piece by Michael Bordo and Harold James on the Eurozone. The piece is titled, ‘The European Crisis in the context of historical trilemmas’ and it makes several interesting observations:
(1) The classic trilemma of monetary policy – fixed exchange rates, free capital flows and independent monetary policy – is extended into other areas with ‘independent monetary policy’ replaced by ‘financial stability’, ‘national policy indepenence’ and ‘democratisation’.
(2) The Eurozone worked quite well as a disciplining mechanism before it entered into effect, but much less well afterwards.
(3) When the democratic/popular backlash occurs, it takes the form of rejection of international/cross-border political commitment mechanism. Voters are surprisingly discerning. Opinion poll data shows a major increase in hostility to the EU in peripheral countries, but with no corresponding unpopularity of the common currency. Hostility to the EU is also evident in parliamentary elections results in Greece and Italy.
(4) The trilemmas are worse in the recent context because of the absence of an escape clause. In the absence of an exchange-rate option, there is a need for greater debt reduction, but that raises a politically awkward question of the distribution of losses between the private and the public sector.
This short paper by Michael Bordo and Harold James is worth reading and reflecting upon.