Monday, June 7, 2010

Why the euro's days may be numbered

My former professor Marty Feldstein has a great column in the Weekly Standard about the euro.  He does a good job of explaining why the euro was always bound to cause trouble.  One of the key reasons: all euro-adopting nations have to have the same monetary policy and the same exchange rate, even though all nations have their own unique economic situation.  Nations with budget deficits and high unemployment are locked into the same monetary and exchange rate policy as those with budget surpluses and low unemployment.  Of course the US has the same issue with the dollar -- all 50 states and D.C. must have the same monetary and exchange rate policy too.  But Feldstein points out that the US gets around this issue because of greater wage flexibility and higher labor mobility than Europe.  Also each US state, unlike Greece, must have a balanced budget each year. 

What does the future hold?  Severe economic retrenchment may or may not happen in Greece.  It remains to be seen whether that country will be able to balance its budget and grow economically.  This is not so much an economic problem as a political one.  The government that adopts the economic policies that Greece needs to return to good standing in the euro-zone runs the risk of being quickly voted out of office and replaced by a populist regime supported by unions and government employees.  Such a government might instead decide to default on its bond obligations and issue a new currency that effectively lowers Greek purchasing power by a substantial amount.  The Argentines did the same thing in 2002.


  1. I'd be interested in your opinion on the effect that 2004 Athens Olympics has on Greece's current economic troubles. The debt created by the 1976 Montreal Olympics are still evident in Montreal. I'm wondering how similar the two Olympic game are from a economic standpoint

  2. I am sure the Olympics did not help, but those expenses were a one-time shot. The systemic issue in Greece is that taxes are way below spending and spending is slated to grow much faster than tax revenue. Too many tax payments appear to be voluntary and too many people work for the government (and retire early with generous pensions). I am not familiar with Quebec's finances, but I would be surprised if debt from 34 years ago was a major issue.