September 18, 2011

NOT THAT THE AMERIZONE IS NECESSARILY FAR BEHIND:

Why the Eurozone Will Come Apart (Bill Watkins 09/18/2011, New Geography)

In Europe, the countries are just too diverse to create a long-lasting currency zone. Languages and cultures are very different across European countries.

A large currency zone works better in the United States. There are fewer differences between, say, New York and California than between, say, Greece and Germany.

Still, even in the United States, states would choose different monetary policies if they could. For instance, California today would prefer a more expansionary policy than would Texas. This is because the Texas economy is doing far better than is California's, and Texas has fewer fiscal challenges than California faces. An expansionary monetary policy would presumably stimulate California's economy, while simultaneously allowing the state to inflate away part of its debt.

This reflects the trilemma. Here's an abbreviation of how Mankiw described the trilemma in a 2010 New York Times op-ed:

"What is the trilemma in international finance? It stems from the fact that, in most nations, economic policy makers would like to achieve these three goals:

Make the country's economy open to international flows of capital.
Use monetary policy as a tool to help stabilize the economy.
Maintain stability in the currency exchange rate.

But here's the rub: You can't get all three. If you pick two of these goals, the inexorable logic of economics forces you to forgo the third."

As Mankiw goes on to say, the United States has chosen the first two options, while China has chosen the second and third, and Europe has chosen the first and third. Right now, Greece and many of the other peripheral countries would like the ability to use the second option.

Posted by Orrin Judd at September 18, 2011 10:22 AM
  
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