Thursday 19 Jul 2018 | 00:49 | SYDNEY
Thursday 19 Jul 2018 | 00:49 | SYDNEY

The euro: Chronicle of a death foretold?


Mark Thirlwell

26 May 2010 15:30

Economists have been given a hard time over the profession's failure to forecast the GFC. Fair enough. But turnabout suggests that at least some of the profession also deserves a bit of credit for accurately predicting many of the problems now facing the euro area.

For example, take a look at the introductory textbook on international economics by Krugman and Obstfeld and you'll find a chapter on optimal currency areas along with a pretty sceptical assessment of whether the European economies meet the associated criteria, as well as a discussion of the problems that this failure might entail. Many others have made similar arguments. So in this case, at least, economic theory turns out to have been a helpful guide to reality. 

But if that's the case, I hear you ask, how come the euro was being touted in the not-so-distant past as a credible contender to replace the US dollar as a global currency? How come so many people were convinced that it would survive its last test, and why do (a now smaller number) think that it will still survive this one? Good questions.

Well, some of what's now going on perhaps makes for a nice case study of hindsight bias. In other words, problems that today appear as inevitable as textbook examples looked quite different before they manifested. 

More importantly, however, anyone looking at prospects for the euro also had to make a calculation about the balance of (adverse) economic and (supportive) political forces, with the latter often tending to over-ride the former in assessments about where European exchange rate policy was headed. Indeed, that same calculation continues to be important when its comes to thinking about the euro zone's future. 

Right from the start, thinking about the future of the European single currency project has involved trying to balance the substantial economic constraints against the strong political will for the project to succeed. Moreover, this political will has meant that each time the project has run into difficulties, a core of West European governments have been prepared in effect to double up their bets and go for an even more ambitious policy.

This story can be traced all the way back to 1970, as I'll show in my next post.

Photo by Flickr user HaPe Gera, used under a Creative Commons license.