Paul Krugman
When the idea of the euro was first broached, there was extensive debate about whether Europe constituted an “optimum currency area”; the key question was whether European nations would have an adequate way to adjust to “asymmetric shocks”, which left some economies more depressed than others. When countries have their own currencies, they can deal with such shocks, at least in part, by devaluing — an argument made most eloquently by none other than Milton Friedman. Lacking that alternative, something else is needed.
So now we have a euro crisis, which — to me at least — hinges crucially on that very issue. What makes Greek problems so intractable is the fact that there’s little hope for growth for years to come, because Greek costs and prices are out of line and will need years of painful deflation to get back in line. Spain wouldn’t be in trouble at all if it weren’t for the fact that the bubble years left its costs too high, again requiring years of painful deflation.
Yet if you look at many discussions of the euro crisis, they simply ignore the adjustment issue. Not to especially bash Marco Pagano, but how can you write a whole essay on the euro’s troubles without so much as mentioning the problem of getting relative costs and prices in line?
It’s tempting to psychoanalyze here — to note that if you pretend that it’s all about fiscal profligacy, the problem seems solvable with a bit more discipline, but if you admit that the original optimum currency area issues are key to the situation, you wonder whether the common currency really makes sense.
But whatever the reason, it’s stunning to see so many smart people pretending not to notice the elephant in the room.
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