The Economics of the Euro

So according to this account from the Economist, it seems that Cameron may just have embarrassed himself this week (via: Chuku Umunna).

Still, the diplomatic mess aside, there is at least a silver lining for the economics profession, in correctly predicting the whole Euro mess. In Tyler's words,

The euro crisis is now here, and it seems our profession should win some of its status back.

The problem is fairly simple. For a stable currency union, you need some way of rebalancing economies running at different speeds. In the US, you have large federal transfers between the individual states, and also large-scale movement of people between states. So if Michigan goes down the tank, it gets subsidised by New York, and its citizens can easily move to another state with more jobs. The eurozone has no such automatic, built-in, large transfers between states, and much bigger language and cultural barriers to large scale movement than within the US.

So to some extent the last 10 years of euro success have been defying some fundamental economic laws of gravity. The latest debacle is basically irrelevant if it doesn't tackle these issues (Gideon Rachman at the FT agrees).

I am no euroskeptic. I love Europe, Europeans, and the convenience of the Euro. And I generally have very little time for the British Prime Minister and the lunatic fringes of his party. But given that Britain is not in the eurozone, I don't really see that trying to make this bold experiment in defying the basics of macroeconomic theory work is much of our business.