Non-conventional non-wisdom on the euro

30 Jul, 2015 at 18:29 | Posted in Economics | 3 Comments

John Cochrane is obviously a big euro fan who doesn’t accept the conventional wisdom that the euro is a bad idea.

However, there seems to be some rather basic facts about optimal currency areas that all economists would perhaps be wise to consider …

The idea that the euro has “failed” is dangerously naive. The euro is doing exactly what its progenitor – and the wealthy 1%-ers who adopted it – predicted and planned for it to do.

That progenitor is former University of Chicago economist Robert Mundell. The architect of “supply-side economics” is now a professor at Columbia University, but I knew him through his connection to my Chicago professor, Milton Friedman, back before Mundell’s research on currencies and exchange rates had produced the blueprint for European monetary union and a common European currency.

Mundell, then, was more concerned with his bathroom arrangements. Professor Mundell, who has both a Nobel Prize and an ancient villa in Tuscany, told me, incensed:

“They won’t even let me have a toilet. They’ve got rules that tell me I can’t have a toilet in this room! Can you imagine?”

As it happens, I can’t. But I don’t have an Italian villa, so I can’t imagine the frustrations of bylaws governing commode placement.

But Mundell, a can-do Canadian-American, intended to do something about it: come up with a weapon that would blow away government rules and labor regulations. (He really hated the union plumbers who charged a bundle to move his throne.)

“It’s very hard to fire workers in Europe,” he complained. His answer: the euro.

The euro would really do its work when crises hit, Mundell explained. Removing a government’s control over currency would prevent nasty little elected officials from using Keynesian monetary and fiscal juice to pull a nation out of recession.

“It puts monetary policy out of the reach of politicians,” he said. “[And] without fiscal policy, the only way nations can keep jobs is by the competitive reduction of rules on business.”

He cited labor laws, environmental regulations and, of course, taxes. All would be flushed away by the euro. Democracy would not be allowed to interfere with the marketplace – or the plumbing.

As another Nobelist, Paul Krugman, notes, the creation of the eurozone violated the basic economic rule known as “optimum currency area”. This was a rule devised by Bob Mundell.

That doesn’t bother Mundell. For him, the euro wasn’t about turning Europe into a powerful, unified economic unit. It was about Reagan and Thatcher.

“Ronald Reagan would not have been elected president without Mundell’s influence,” once wrote Jude Wanniski in the Wall Street Journal. The supply-side economics pioneered by Mundell became the theoretical template for Reaganomics – or as George Bush the Elder called it, “voodoo economics”: the magical belief in free-market nostrums that also inspired the policies of Mrs Thatcher.

Mundell explained to me that, in fact, the euro is of a piece with Reaganomics:

“Monetary discipline forces fiscal discipline on the politicians as well.”

And when crises arise, economically disarmed nations have little to do but wipe away government regulations wholesale, privatize state industries en masse, slash taxes and send the European welfare state down the drain.

Greg Palast/The Guardian


  1. One cannot ignore that Greece is a distinct political entity that entered upon an international treaty. That treaty is a binding contract, which has imposed operating constraints upon all signatories to it. One so often hears the suggestion that Greek banks ought to default. Their default does not relieve Greece of its obligation to maintain the standards required by the treaty. Default, in and of itself, is abrogation of the terms of the treaty. Membership within the European Monetary Union is a privilege, not a right. Failure to maintain the standards required by the Maastricht treaty portends withdrawal of that privilege. Adherence to the rule of law is more fundamental to the precepts of Western Civilization than any theory of economics.

  2. I think we should be careful here. We should be very careful of the “conventional view” which is based on the very gadgets you criticise – however convenient it is to go along with them. While I have my reservations about the Euro, especially in the expanded EU, we should not accept open economy ISLM and Optimal Currency Areas as the basis of the analysis. Similarly, the justifications for fiscal expansion in the zero lower bound can be “shown” with ISLM gadgets – but that is vacuous analysis. In this case, returning to the Drachma alone is not the answer (and the Greek people seem to agree) – the problems are fundamental – relating to trade, industrial and institutional structures. The question is how do you deal with that – fiscal union may in fact be the best way to fix it- and some people think, that however clumsily – this is in fact already happening. What I oppose is austerity – but this is not necessarily directly related to the exchange rate regime. I think Jeff Sachs has been one of the better commentators on this issue.

    What is happening in Greece is a tragedy, but the problems to be fixed are deeply entrenched.

  3. […] Source: Non-conventional non-wisdom on the euro | LARS P. SYLL […]

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