A reader has pointed me towards this nice post by Michael Pettis, which strays from his usual Chinese turf to take a look at Europe. It makes the same points as the ones Martin Wolf has been making about the need for the large countries with ‘fiscal room’ in the Eurozone, particularly Germany, to do everything they can to maintain aggregate demand in the Eurozone.
This should be obvious to anyone with an understanding of intermediate macroeconomics, so I won’t comment on it. But Pettis also cites Barry Eichengreen’s classic Golden Fetters, which readers may not be familiar with, and in particular Barry’s views on the implications of democracy for the maintenance of the gold standard. That system required adjustment through deflation for countries suffering negative shocks. This was not necessarily a problem in the 19th century, when wages and prices were flexible, and universal suffrage was rare. By the 20th century, however, rigidities in the economy were such that deflation implied unemployment; and democracy meant that this economic cost translated into a direct political cost for policy makers. The gold standard, inevitably, broke down when confronted with the pressures of the Great Depression.
I don’t think it’s fair to compare the euro to the gold standard, as Pettis does. The ECB has lowered interest rates, not raised them, although not by as much as other central banks; and both the French and the Germans have applied fiscal stimulus to their economies. On the other hand, it is true that adjustment in the PIIGS now implies deflation there (unless, as the FT points out today, inflation in the Eurozone as a whole is increased). This is going to be both economically and politically costly, and will have unpredictable effects, especially if the Eurozone as a whole experiences a double dip recession.
I suspect that Ireland will find these adjustments easier to bear than most, since emigration gives us both an economic and a political safety valve. (That was a positive rather than a normative statement by the way.)