EMU And Ireland's Problems
There has recently been an argument in the Swedish blogosphere over Ireland and the European Monetary Union. It started with neocon blogger Dick Erixon approvingly quoting an article in Swedish news paper Dagens Industri (not online) which basically said that because Ireland is part of the euro area, it faces problems because this disables them from lowering interest rates and thus also lowering the value of its currency. To this libertarian (or libertarian-leaning) bloggers Wille Faler and Johan Ingerö criticized Erixon and pointed out that such inflationary policies is not healthy.
Economics has never been Erixon's strong side, and he is certainly dead wrong when he implies that Ireland needs more inflation. However, while Faler and Ingerö are on the right track, I do not find their answers fully satisfactory, so I will therefore go to the bottom of this issue.
There is nothing wrong with monetary unions, per se. Quite to the contrary. It is likely that under a free market monetary system (i.e. a gold standard) we would basically have a single currency in all countries with this free market system. So in this aspect, monetary unions represents a replication of free market conditions even if it is paper based and run by a central bank as in the case of the euro. Because it creates more market like conditions, a monetary union will also be associated with increased trade, and therefore increased specialization and higher structural growth.
However, the issue is more complex than this. Because the euro is paper based and run by a central bank it is not certain that for all countries, it would be preferable (i.e. more similar to free market conditions) to join the euro rather than to have its own monetary policy. That is only the case if an independent monetary policy would be less sound, equally sound or only slightly sounder. If on the other hand an independent monetary policy would be significantly sounder than the policy pursued by the ECB, than it would certainly be preferable to have an independent monetary policy*.
Contra factual speculation always involves a degree of uncertainty, but it seems likely that in the case of Ireland an independent monetary policy would have indeed been significantly sounder. For years, Ireland has had high inflation and a housing price bubble because of the low interest rates set by the ECB. Had Ireland had an independent monetary policy it seems likely they would have had higher interest rates which would have contained these excesses to some extent and thus meant that Ireland would have had less problems now.
The problem here is not the principle of monetary unification, but rather that the ECB have pursued a too inflationary policy. This has hit Ireland disproportionably hard because their economies have boomed for other reasons. These strong economic conditions have made the Irish much more willing to respond to the ECB's low interest rate policy by increasing their debts than in for example Germany and Holland, where people have been reluctant to borrow more. Or to use, more technical economics terminology the price elasticity with regard to interest rates have been much higher in Ireland than in Germany and Holland.
There are thus good reasons to blame Ireland's problems on EMU (given the ECB's inflationary policies), but not because it stops them from inflating more now but because it has compelled them to inflate too much in the past. They thus arguably should not have joined in 1999, but withdrawing at this point is not a good idea. But in order for EMU to work for all members, the ECB must try to replicate the non-inflationary conditions of a gold standard as well.
Economics has never been Erixon's strong side, and he is certainly dead wrong when he implies that Ireland needs more inflation. However, while Faler and Ingerö are on the right track, I do not find their answers fully satisfactory, so I will therefore go to the bottom of this issue.
There is nothing wrong with monetary unions, per se. Quite to the contrary. It is likely that under a free market monetary system (i.e. a gold standard) we would basically have a single currency in all countries with this free market system. So in this aspect, monetary unions represents a replication of free market conditions even if it is paper based and run by a central bank as in the case of the euro. Because it creates more market like conditions, a monetary union will also be associated with increased trade, and therefore increased specialization and higher structural growth.
However, the issue is more complex than this. Because the euro is paper based and run by a central bank it is not certain that for all countries, it would be preferable (i.e. more similar to free market conditions) to join the euro rather than to have its own monetary policy. That is only the case if an independent monetary policy would be less sound, equally sound or only slightly sounder. If on the other hand an independent monetary policy would be significantly sounder than the policy pursued by the ECB, than it would certainly be preferable to have an independent monetary policy*.
Contra factual speculation always involves a degree of uncertainty, but it seems likely that in the case of Ireland an independent monetary policy would have indeed been significantly sounder. For years, Ireland has had high inflation and a housing price bubble because of the low interest rates set by the ECB. Had Ireland had an independent monetary policy it seems likely they would have had higher interest rates which would have contained these excesses to some extent and thus meant that Ireland would have had less problems now.
The problem here is not the principle of monetary unification, but rather that the ECB have pursued a too inflationary policy. This has hit Ireland disproportionably hard because their economies have boomed for other reasons. These strong economic conditions have made the Irish much more willing to respond to the ECB's low interest rate policy by increasing their debts than in for example Germany and Holland, where people have been reluctant to borrow more. Or to use, more technical economics terminology the price elasticity with regard to interest rates have been much higher in Ireland than in Germany and Holland.
There are thus good reasons to blame Ireland's problems on EMU (given the ECB's inflationary policies), but not because it stops them from inflating more now but because it has compelled them to inflate too much in the past. They thus arguably should not have joined in 1999, but withdrawing at this point is not a good idea. But in order for EMU to work for all members, the ECB must try to replicate the non-inflationary conditions of a gold standard as well.
posted by stefankarlsson at 10:14 PM
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