Some econ stuff:
According to Reuters, a bunch of European economic mucky-mucks have scheduled an emergency meeting about Italy’s financial troubles and the eurozone debt crisis. This comes after Ireland, Greece, and Portugal have received bailouts to the tune of €273 billion (worth roughly $383 billion today, worth God-only-knows-what tomorrow or the day after that). Other member states of the eurozone aren’t especially thrilled about the bailouts or about the effects on their own economies.
Whenever there’s news about euromeltdowns and the subsequent bailouts, I am reminded of a paper I wrote back in college about whether the then-proposed eurozone would be an optimum currency area (OCA). An optimum currency area is the geographic area within which it is most efficient to use a single currency. OCAs are not necessarily defined by political boundaries; for instance, it may serve neighboring countries to adopt the same currency. On the other hand, a large country such as the US may contain multiple OCAs, as argued in this working paper from the Chicago Branch of the Fed (why is it that whenever I get to the second “c” in Chicago, MS Word auto-suggests “Chicago Pizza”?).
What makes a currency area optimal? Here’s me, in a term paper from 1996/7:
Within a nation which uses a single currency or within a monetary union which links its currencies with fixed exchange rates, the currency area is optimal when:
- There is nominal flexibility; i.e., prices and wages are flexible, OR
- Factors of production are internally mobile, and
- There are no margins of fluctuation between/among exchange rates, and
- Currencies are irreversibly convertible, in that they can freely be exchanged for the backing assets, and
- There is liberalization of current and capital transactions, and
- There are similarities in demand shocks (i.e., financial market integration, openness of economy, diversification of economy vis-à-vis Feldstein’s and Tavlas’ definitions), and
- There are many returns to purchasing power parity over the long run, and
- The “national propensities to inflation” are consistent throughout the currency area.
(I think I remember what some of this means.)
Let me try to boil it down to two points: first, the more freely that businesses, workers, resources, and capital can flow within an area (i.e., the more “factor mobility” in an area), the better a single currency will serve it. So if linguistic, cultural, or educational differences hamper labor mobility within a given area (say, one that spans a continent with over 300 million people living in 17 nation-states and speaking nearly as many languages), that area’s probably not an OCA.
Second, levels of inflation (or deflation) have to be similar throughout the OCA. So if the more northern-central part of a currency area is used to very low inflation, and the southern part of a currency area is used to higher inflation, that currency area needs to be split up.
Anyhow, would the then-proposed eurozone constitute an OCA? Long story short: no. Nobody asked me, but no.
There might be OCAs within the eurozone. For instance, I wrote (and still think) that Austria, Denmark, Germany, and Holland would be better off as a distinct currency area than as part of the eurozone. Factor mobility among those countries is relatively high and the cultural and linguistic differences are relatively low. They tend to favor low inflation (though I believe Holland’s inflation is a bit high right now), and the central banks of Holland, Austria and Denmark tend to follow the lead of Germany’s central bank. Again, nobody asked me.
It’s possible that using a single currency might bring about greater internal factor mobility or greater similarity of demand shocks, but— actually, let me say this part in English. The eurozone may prove to be a good idea in the long run, but I wonder whether it was driven by the notion that a more united Europe would automatically be a more efficient Europe. Looks like they jumped the gun.
True, even if Austria or Germany or whoever had stayed out of the eurozone, they’d still be hurt by the economic troubles in Portugal or Greece or Italy. That’s how globalization and interdependence work. But if they’d stayed out, they’d certainly be feeling less pain. Now they’re stuck. The Germans are probably kicking themselves, the Swiss are probably patting themselves on the back.