Moving on From the Euro

SAINT-PIERRE-D’ENTREMONT, FRANCE – European Monetary Union was never a good idea. I remember my surprise when, as a young assistant professor, I realized that I was opposed to the Maastricht Treaty. I believed then – and still do – that European integration is a very good thing. But the textbook economics I was teaching showed how damaging EMU could be in the absence of European fiscal and political union.

Nothing that has happened since has convinced me that the textbook was excessively pessimistic. On the contrary: it was far too optimistic. Life is strewn with banana skins, and when you step on one you need to be able to adjust. But the monetary union itself turned out to be a gigantic banana skin, inducing capital flows that pushed up costs around the European periphery. And adjustment – that is, currency devaluation – was not an option.

Furthermore, most textbooks of the time ignored the financial sector; thus, they ignored the fact that capital flows to the periphery would be channeled via banks, and that when the capital stopped flowing, bank crises would strain peripheral members’ public finances. This, in turn, would further erode banks’ balance sheets and constrain credit creation – the sovereign-bank doom loop that we have heard so much about in recent years. And no textbooks predicted that European cooperation would impose pro-cyclical austerity on crisis-struck countries, creating depressions that in some cases have rivaled those of the 1930s.

It has been obvious for some years that the “actually existing EMU” has been a costly failure, both economically and politically. Trust in European institutions has collapsed, and political parties skeptical not just of the euro, but of the entire European project, are on the rise. And yet most economists, even those who were never keen on EMU in the first place, have been reluctant to make the argument that the time has come to abandon a failed experiment.