The current big question over here in Europe is whether Greece is going to manage to stagger through the country’s debt problems or is going to crash and burn into default and the subsequent likely exit from the euro. Many are saying that leaving the euro would be very bad for the country and its economy: and it certainly wouldn’t be pleasant in those first few months. However, interesting new research shows that there’s not really been any benefits from having the euro in the first place. So, leaving it isn’t like to to produce any ill effects once the transition itself is over with.
The point here goes back to the basic macroeconomics of the very idea of currency unions in the first place. To be very simplistic about it there’s a positive effect of a currency union, increased trade, and a negative effect coming from the entire area having to have the same monetary policy. These two effects working in opposite directions means that there’s some area over which to have a single currency is the Goldilocks area, neither too hot nor too cold. More formally, this is called an optimal currency area.
The basic points are obvious. If the 100,000 people of my native Bath all use different currencies then trade between the citizenry is going to be rather difficult. If we all use the same currency it will be easier and there will be more trade. Since trade is what gives us Smithian growth (from Adam Smith, the specialisation and division of labour and the trade in the resultant production), makes us all richer, this is a good idea. However, it’s possible to have too much of a good thing. If we’re using the same currency then we must, by definition, have the same monetary policy. And the larger the area we cover the more likely it is that we’ll have two more more areas within it which will react differently to an external or asymmetric shock (the definition of that second simply being a shock that hits different areas in different ways). This is whatPaul Krugman has been talking about with Finland and everyone has been talking about with respect to the property booms in Ireland and Spain a decade back.
All of this is background: people have been chewing over how optimal the euro area is ever since the idea was first floated (hint: it’s not optimal). However, note that the size of that optimality depends upon the strength of the two effects. And if that increased trade effect is smaller then the optimal area becomes smaller. And what this most recent research seems to be showing is that there’s no extra trade effect at all:
More importantly, we find that the trade effects of EMU are different from other currency unions. But, most disturbingly, we find that the precise econometric methodology used to estimate the currency effect on trade matters. A lot. In the large, we find no consistent evidence that EMU stimulated trade. Indeed, we are forced to conclude that econometric methodology matters so much that it undermines confidence in our ability to estimate the effect of currency union on trade.
A reasonable rule of thumb is that if the effect you’re looking for varies a lot dependent upon the method you’re using to look for it (assuming that all the methods you are using are reasonable) then what you’re finding is not actually the effect, but variances due entirely to the measurement method. But even putting that aside they find that there’s a small through zero to possibly even negative effect upon trade of the currency union of the euro. Or, as we might put it, there’s no benefit and we’re left just with the costs.
Things that cost us but have no benefit are things that we shouldn’t be doing. Thus, clearly, we shouldn’t be having the euro. Or, as we might put it, everyone should leave it, not just Greece.
That this accords with my prior prejudices is just peachy and has nothing at all to do with the speed with which I am embracing this research. No, really, nuttin’. Honest.
It’s worth pondering why this should be so for research into earlier currency unions showed distinct and large positive effects on trade. A first stab at an answer would be that earlier currency unions weren’t in fact just currency unions. They were also customs unions. And it’s that second that produces the large effects. In the EU though the customs union predated (depending upon whether you want to think about moves to it or the full Single Market) by a decade or several. So, by the time currency union arrived a lot of the trade integration that the earlier studies were finding had already happened. I don’t insist that that’s so: only that it looks reasonable to me.
But the end result is still the same. The euro is imposing costs as a result of having one monetary space, one monetary policy, and we’re not getting any of the trade benefits we thought we were going to get. So, let’s stop the experiment and everyone, not just Greece, leave the euro.
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