What Paul Krugman is saying about Ireland and the Eurozone is not wrong. But he keeps missing the most important point. And it's bugging me.
And sure, the Eurozone is less of an Optimal Currency Area than the US, and that matters too.
But the lender of last resort matters more. The US has an effective lender of last resort. The Fed has the political authority to print as many US dollars as are needed. The only effective limits are the risks of inflation and moral hazard. The Eurozone does not have an effective lender of last resort. The individual Eurozone countries do not have their own central banks. The ECB lacks the political authority to print as many Euros as are needed.
Suppose you abolished the US Federal government. So you needed all 50 State governments to agree before the Fed could act as lender of last resort to one of those State governments. And suppose some of those US State governments had as much debt as Greece, or were bailing out their banks like Ireland. Think all 50 State governments would agree on anything? I don't. (And they all at least speak the same language, and really do all think of themselves as part of the same nation). Think it would matter? I do.
If Ireland had its own central bank, and saw the risk of deflation and recession, and interest rates on 10 year government bonds at 9%, what would it do? It would start buying a lot of government bonds. It would push interest rates down, and push expected nominal GDP growth up. That would get rid of a lot of the problem right there. All of the problem? Maybe not. But it would give Ireland's fiscal austerity a fighting chance to work. It's a lot easier getting your debt/GDP ratio under control when nominal interest rates are only a percentage point or two above the growth rate of nominal GDP.