The euro has been the greatest success of economic science but is becoming the most humiliating defeat for the economics profession. I thank Il Sole 24 Ore for it openness in allowing me to set forth and discuss a paradox that concerns us all, economists or otherwise, in the framework of a high-level debate.
The euro has been a big success of economic science: I do not know of any other case in which economics was able to so exactly forecast the consequences of a political decision. Let me give three examples. The ECB’s last Economic bulletin complains of weak growth of salaries in the euro area, which suggests that official unemployment data may be underestimated. We are therefore in the situation predicted by Rudiger Dornbusch in 1996, when he warned that monetary union would “transfers to the labor market the task of adjusting for competitiveness”, increasing unemployment. This is what we call “internal devaluation”, a mechanism on which a monetary union has to be ableto rely, if it wants to survive (this was demonstrated by Mundell in 1961). Secondly, despite defeats, euroscepticism is advancing all over Europe and is casting doubt on the model of European political integration. This is exactly what Nicholas Kaldor predicted in 1971, when he warned that “if the creation of a monetary union and Community control over national budgets generates pressures which lead to a breakdown of the whole system it will prevent the development of a political union, not promote it”. Finally, even before Macron’s first day in office, Germany’s rejection of the French proposal of Eurobonds clarified its continued position of intransigence: an excellent example of what Martin Feldstein observed in 1997: “a French aspiration for equality and a German expectation of hegemony are not consistent”. It is all going as the best of us predicted, so that an intellectually honest economist could express the euro question in four words: “We told you so!”
Certainly this is a unproductive attitude, but still better than what we have seen since 2008. Instead of mapping the way out of a trap that it described so well, the economics profession is discrediting itself by using dubious arguments to defend a project it predicted would fail (regarding the quality of the arguments, I agree with Perotti’s post in LaVoce.info on 12th May).
The project is incoherent for a very simple reason, illustrated by Alberto Alesina in 1997 in his comment to Obstfeld’s “Europe gamble”, when he criticised monetary union: a common market only makes sense if it sustains growth when shocks come from the rest of the world (as in the American crisis of 2008). Unfortunately, the single currency frustrates the benefits of the common market because in a monetary union, macroeconomic adjustment necessarily involves internal devaluation (reduction of salaries): by cutting salaries, internal demand is repressed precisely when it is needed to take up a temporary lapse in foreign demand.
It is difficult to defend an incoherent project while remaining coherent with the data, the theory or simply oneself. Thus the euro is becoming the most humiliating defeat of the economics profession, which by championing incoherent arguments is discrediting itself in the eyes of the public. Let me offer three more examples drawn from this debate. Paul De Grauwe’s idea that internal devaluation policies in Greece and Spain “were very successful” is somewhat incoherent with the data: in 2016, unemployment was 23.7% in Greece and 19.6% in Spain. It is not so hard to decrease salaries when one person in five is unemployed. Against this backdrop, more than a success of Greece and Spain, De Grauwe’s analysis shows a loss of contact with daily life. This will certainly not help people to like our profession.
John Cochrane’s idea that money is irrelevant for growth (economists say that money is “neutral”) not only clashes with major scientific results, such as Dani Rodrik’s analysis of the role of excessively strong exchange rates in slowing the growth of a country, but also with what the European institutions are finally admitting through clenched teeth: the reforms are causing deflation and failing to promote employment in any decisive way (footnote 23 in the above ECB Economic bulletin). The best economists had also addressed this point: the negative consequences of structural reforms on the productivity of labour were illustrated by Robert Gordon in 2008. For Cochrane, money is like oil in a motor. The metaphor is (unwittingly) correct. Bad management of oil has long-period consequences like bad management of currency: in the first case the head fuses and the motor stops; in the second a continent, and the world economy stops.
If De Grauwe is incoherent with data and Cochrane with theories, then Feldstein is incoherent with himself. His idea that credit-debt relations cannot be redenominated in new units of account (i.e. Italians paid in new lira “would still have mortgages and other large debts denominated in euros”) is incoherent with what he acknowledged in 2012. When writing about Greece in Foreign Affairs, he admitted that “the Greek government could start creating new drachmas and declare that all contracts under Greek law... are payable in that currency” (including “all bank deposits and bank loans”).
All this incoherence leads in one direction: it aims to fuel an irrational "project fear" that is self-defeating, because it is not credible in communicative terms after so many previously threatened consequences that failed to eventuate (consequences of Brexit, the election of Trump and the victory of “no” in the recent Italian constitutional referendum). It is regrettable to see Barry Eichengreen, a brilliant scholar on the demise of the gold standard, say that “history does not reverse itself”. This “rectilinear” idea of progress would make any Italian high school student smile, but above all and once again, it puts our profession in a bad light. Our task as intellectuals and economists is to indicate and study alternatives, not block them by chanting there is no alternative. If we are not up to this challenge, society will discard us and we will have to admit that we deserved it
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