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December 10, 2010

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Jonathon Martin

Could you explain/comment on a couple of things. I am not an economist so they are unclear to me:

1) Why does a few basket-case countries leaving the euro, end the euro? Cannot the remaining countries carry on with a smaller but stronger monetary union?

2) Is it fair to say the euro failed due to lack of political unity when in fact the circumstances were ones of unparalleled economic irresponsibility.

Michele Zini

Dear Professor Rodrik,

It pains me (as an Italian and a European) to read your post, probably even more that it pained you to have written it!

Deep inside I think you are right although I have to admit that I dont understand how practically one would go about in leaving the Euro. And I think we are underestimating the long term implication of the change.

I am sure you've seen The Economist's article on this topic from last week's edition. They raise a number of points that left me puzzled, and were wondering whether you had any thoughts.

First thing, countries need a short term tool to restore economic competitiveness and balances and leaving the euro cannot be done overnight. The decision to adopt the common currency was taken in the late Nineties and implemented only 2001/2002.

Second thing, the prospect of leaving the Euro might trigger bank runs and capital flights. How does one deal with that? Indeed, as The Economists argues, capital controls can be raised (and this might be easier to do), but one would assume you also need to restrict movement of people - because how are you going to stop an Italian from withdrawing his Euro if Italy is about to leave the EMU and take them to Germany?. I really don’t see how countries would get away with that in a socially sustainable and peaceful manner.

Thirdly, and most importantly, don’t you think that the current situation in the PIGS country is another symptom of a deeper problem and as such leaving the Euro will only buy you some time but might hurt these countries in the long run?

Take Italy and assume they leave the Euro. Assume that they manage the transition (which is a HUGE assumption). Yes, in the short run they might be able to restore competitiveness by a sudden depreciation of the "New Lira". My guess though is that the country, because it is fundamentally irresponsible (fiscally and politically), would soon start competitive devaluations, and soon enough it would find itself exactly where it was 15 years ago (where the only way to fix things was to sign to an "external commitment device" that forced upon politicians a few years of discipline).

In other words, what if leaving the Euro results in a huge adjustment cost in the short run, a good medium term economic performance (as the benefits of independent monetary policy and a low currency restore balance and exports), followed by a future of spiraling inflation, raising interest rates, and fiscal mismanagement?

What would this entail for Italy, and more importantly, for the new Europe (socially, politically, and economically)?

As you teach us, when you take action you want to intervene on the causes of the problems not on the symptoms (although when you have a bad headache it does help to take aspirin). To me the problem is not the Euro (at least for several countries in the EMU). The problem lies elsewhere and leaving the Euro will only be a way to allow the real culprits to get away with their misdoings.

Kind regards
Michele

Geert Vansintjan

Devaluations are less a solution the more a country is globalised. When even services are delivered from neighbouring countries, the gap between the rate of a devaluation and the rate of inflation narrows.
Indeed, austerity can be spread amongst the rich and the poor, while the cost of devaluation falls disproportionally on the poor, while the rich can get their assets abroad and get cheaper services.

Michiel Jonker

Though I am an entrepreneur, I love history too. From a historical and political point of view I cannot see that these countries will be excluded from the Eurozone. Most of them formed part of the core of the Roman Empire... and the idealistic sentiment behind the idea of the European Union is the resurrection of the Roman Empire. In my opinion these countries will have no other choice to stay and reform in order to fit in… So, my argument is this: though money makes the world turn round, idealistic “passions” also play a role…

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Errr YES! Many countries must realise that the Euro isn't working for them. Thinking particularly of Greece, Italy, and Spain here who are pulling the value down on the currency.

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