Fixed exchange rates and Blame Thy Neighbour

There is a parallel universe in which the Euro was never invented, and the Eurozone countries kept their own moneys and their own central banks, with flexible exchange rates. I think the economic outcomes would have been better. But let's just suppose they weren't.

Suppose that each of those independent central banks had screwed up their monetary policies in their own independent ways, and we ended up with exactly the same pattern of unemployment rates and inflation (deflation) rates across the Eurozone countries that we actually observe today. The Bank of Greece in particular screwed up very badly in my parallel universe, by running an extremely tight monetary policy. I know this is very hard to imagine, but bear with me.

Would international relations be better or worse in my parallel universe? Would the Greeks be violating Basil Fawlty's first rule when negotiating with the Germans?

I think international relations would be better. I think that countries would be blaming themselves and not their neighbours. Flexible exchange rates would make it more likely that countries would take responsibility for their own predicaments, and start doing the reforms to monetary policy, fiscal policy, and economic policy in general, that they would need to undertake.

Optimal Currency Areas isn't just about asymmetric shocks, transactions costs, labour mobility, and fiscal transfers. It's about international relations and countries getting their acts together. Flexible exchange rate fences good neighbours make.

[I'm stealing Simon Wren-Lewis' thought experiment, and modifying it.]

Comments

[Min]

Well, first, the central bankers are unlikely to be independent in fact, but suffering from a kind of group-think.

Second, would the Europeans nations have adopted beggar thy neighbor policies? Would they be trying to out export each other? Would Greece be selling off assets in an attempt to attract foreign funds? Would wages be under attack in an attempt to be competitive?

It seems as though one of the best things to do during the Great Depression was to go off the gold standard. The Eurozone has something like the gold standard, but they cannot go off of it. Without the Euro, that would be the case, but if the central banks acted as if they were on the gold standard, even though they were not, would things really be better?

[Min]

A couple of things:

The first statement does not refer to central bankers in this world, but in the alternate one.

Typo in the last statement. It should be, "that would not be the case".

[Kevin Donoghue]

I agree with the gist of this post, but I think it is well-nigh impossible to imagine an economy with its own central bank getting into the kind of mess that Greece got into. The Irish case is even harder to visualize. How on Twin Earth could Anglo Irish Bank have operated, if it had to raise all its deposits in Irish pounds (or punts as the international press generally called them)? Without the Eurozone the supply of suckers would have run out much sooner.

[Min]

Kevin makes a good point. The central bankers have to be in collusion in the alternate universe. After all, most of the so-called Greek bailout went to French and German banks. The French and German CBs in the alternate universe may have bailed their banks out, but how does that generate Greek debt?

[Kenneth Duda]

Nick, this is a great point. The costs of non-optimal currency areas run deep.

-Ken

[Jacques René Giguère]

As Martin Wolf recently wrote: "If you have your own currency, you can have your own society model." (from memory.) That model include having your CB screwing up in its own way. ANd nobody noticing much.

[Nick Rowe]

Kevin and Min: yep. It's hard to imagine that parallel world staying parallel, and not diverging off in a different direction.

Thanks Ken!

Jacques Rene: yep. And nobody else caring as much either.

[marcus nunes]

Nick, even in the fifth best world of the Euro, things could have been much better, if only Germany showed true leadership and not just cheap moralizing!
https://thefaintofheart.wordpress.com/2015/02/19/what-price-success-2/

[simon wren-lewis]

Nick - there is an alternative view, which I think Charles Goodhart talked about when the Euro was formed, and it is this. It is very difficult to fight a war with a country you share a currency with.

[Jacques René Giguère]

Marcus: in german view, moralizing and denying a century of macro is the point of showing leadership.

[Nick Rowe]

marcus and Simon: fair points.

(I found both your comments in the spam filter, but I hope that by fishing them out I am training Typepad.)

[Parick]

"It is very difficult to fight a war with a country you share a currency with."

The number, frequency and ferocity of civil wars between ethnic groups within a state would suggest that a common currency does little to pacify populations bent on murder and mayhem.

[Patrick]

Oops. Sorry. The name my previous comment contains a typo. Typepad should really allow the user to edit their own posts!

[Derivs]

"I think Charles Goodhart talked about when the Euro was formed, and it is this. It is very difficult to fight a war with a country you share a currency with."

I agree with Patrick. Poorly thought out statement, wishful thinking. Lack of countries that share currencies is the only reason for few occurrences. Civil wars show how wrong the statement is.

[Nick Rowe]

IIRC, I used to hear a variant of Charles Goodhart's view regarding the original post-war Franco-German agreement when they shared the iron/steel industry, from which the EU evolved. It was hard/impossible for France and Germany to go to war when they didn't have their own iron/steel industries.

[baconbacon]

Even if the Goodhart view was correct the opposite could well be true- that if someone sharing your currency goes to war you will find it very hard to stay out of that war. Complcated entanglements effected the sccope of WW1, and not in a good way.

[Jacques René Giguère]

Humans are always not that far from murder and mayhem. In the early 90's Sarajevo and Baku were among the city in the world with the highest level of ethnic mixing as shown by intermarriage. We know hoe it turned out.
Today, Bosniak are now speaking a "different" language" as they refuse to call it serbo-croation.
"To paraphrase someone "Baku is a faraway place about which we know nothing" but the Armenian-Azeri war was as bad as the Yugoslavian affairs.)
So anything that do not positively absolutely bting higher peace should be viewed with suspicion. As Krugman said, the Germans are clearing the way for Golden Dawn.

[Nick Rowe]

Jacques Rene: I blame the Euro, more than the Germans. The Greeks are probably doing bad things to German politics too.

[Jacques René Giguère]

But the euro, in its basic concept, is german ordoliberalism ( a fancy name for 19th century hard-right) mixed with french gold obsession. They are responsible, if only because they are the bigger one and set the rules. Not understanding your own rules consequences is not an excuse but an indictment.

[Nick Rowe]

Well, it looks like the Greeks have surrendered. I thought the Greek government was maybe trying to get out of the Euro, and was just trying to get the Germans to take the blame for Grexit, because Grexit is unpopular with Greek voters. Back to square one, except the Germans probably trust the Greeks even less now, and the Greeks dislike the Germans even more. All for nothing, AFAICS.