Arnold Kling  

Tyler Cowen on the Euro

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His NYT column is a must-read. The bottom line:


the euro, in retrospect, appears to have been a misguided attempt to equalize the values for some very unequal assets, namely the bank deposits of strong countries and those of weak countries.

Modern governments seem to play this role in the monetary system. For example, deposit insurance serves to equalize the values of deposits in strong and weak banks.

What I see Cowen as saying is that the euro project inevitably entailed a sort of deposit insurance for banks. However, this was never formalized. No european-wide insurance fund was set up, and no risk-based insurance premiums were charged. Instead, it was more or less expected that each national government would prop up its own banks. But this assumption has proven unworkable.

Read the whole thing.


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COMMENTS (4 to date)
Philo writes:

The EU authorities should have signaled convincingly that they would not allow the Irish government to convert bank deposits denominated in euros into lesser-valued deposits denominated in a new Irish currency. They should have made it clear that they would impose crippling sanctions on Ireland if the Irish government attempted this. This would have made potential depositors confident about the Irish banks. The "silent run" on Irish banks indicates that the EU authorities did not send the required signal. The situation can be saved only if they can now convince the public that they will not permit national governments to repudiate the Euro-denominated debts of their banks--that they would impose sanctions sufficiently harsh to make such an action unattractive. (Tyler remarks: "Any such breakaway country would incur the wrath of the European Union"; he fails to remark that the EU has not made its "wrath" convincing enough. Barroso is giving up his chance to play Lincoln--to *save the (Currency) Union*.)

Of course, the ECB could inflate its way out of the crisis; regrettably, it seems to lean instead toward deflation.

This article illustrates the casual looseness that has come to mark Tyler's writing. The "silent run" has nothing to do with Gresham's Law; it is more a case of *good* money driving out *bad*! And the two moneys are not "euros inside and outside Ireland"; they are *euro-denominated bank deposits* inside and outside Ireland.

The obvious answer to Tyler's final question: short-run patches often *work*.

Daublin writes:

Another central plan turns out to be fundamentally unsound.

The depressing part is that these are major economies that the Eurocrats are toying around with. If they had done something simpler -- like local currencies with floating exchange rates -- then they would have a much more reliable system.

If someone designed a bridge or a skyscraper that way, they'd never get it approved. No one would want to use a bridge or a skyscraper that was built with experimental methods and lots of boasting about how it's the patriotic way.

Robert Smith - Dallas writes:

Philo,
Given we are talking about sovereign countries here, what, exactly, sanctions could the EU impose and achieve success? Keeping in mind two things: 1. Given there is ongoing trade between the members, any sanctions on countries thinking of leaving the EU egregious enough to be successful may result in unforeseen consequences on those member states that choose to remain. 2. These countries are not at war. So, it strikes me that the EU may choose to only invoke half-measures, with the result being the worst scenario where the weaker currencied nations still leave and the Euro is perceived as damaged, leading to its total dissolution.
My concern is that those individuals who mistakenly believed that they could manipulate national economies, via a common currency,are also mistaken in their ability to make the appropriate corrections.

Hoover writes:

Philo says: "And the two moneys are not "euros inside and outside Ireland"; they are *euro-denominated bank deposits* inside and outside Ireland."

Hi Philo. Could you explain the difference?

As a layman, I can't see the importance of the distinction but I'm open to enlightenment!

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