The Mess that is the Euro – and What May Keep it Together

As I pointed out before, the basis of a monetary union is the agreement of all member states on a uniform development of the price level across the member states and nothing else.

So, ensuring that Unit Labour Costs and prices across member states develop in line with inflation in the European Monetary Union (EMU) as a whole is the only condition that needs to be fulfilled for the EMU to work. However, once Unit Labour Costs and prices across member states have been allowed to substantially diverge, the realignment of relative prices is extremely painful due to the absence of fiscal transfers and because (mainly due to language barriers) labour mobility is significantly restricted within the EMU.

Thus any substantial divergence of Unit Labour Costs and prices across member states threatens the survival of the EMU because member states are, of course, tempted to avoid the high cost of ‘internal devaluation’ by leaving the currency union (i.e. by devaluing externally instead).

Given that (due to lack of labour mobility and lack of fiscal transfers) a realignment of wages and prices is so costly, the EMU needs a mechanism to prevent asymmetric shocks from leading to substantial differences in Unit Labour Costs between member states.

Given that member states don’t have their own monetary policy any more, fiscal policy is the only tool left to achieve such a mechanism. That is, instead of the nonsensical 3% deficit limit, there should be a fiscal rule requiring member states to set the budget balance in such a way that Unit Labour Costs and prices develop in line with inflation in the EMU as a whole.

Using fiscal policy in such a way involves inefficiencies and may not work anyway. But if Euro policymakers want to prevent the Eurozone from breaking apart, they should at least try this approach because the EMU’s current framework virtually guarantees failure.

Do I believe the necessary adjustments to the Eurozone’s architecture are going to be implemented, preventing its break-up?

No, I don’t.

Most of the European policymakers haven’t even recognised the problem.

Another Seasteading book

A couple of weeks ago, I posted about Joe Quirk’s and Patri Friedman’s book on Seasteading. Now another book on this topic has been published: Victor Tiberius’ Seasteads – Opportunities and Challenges for Small New Societies.


Taking a more academic approach, the book can be considered complementary to Joe Quirk’s and Patri Friedman’s book on Seasteading.

It consists of essays mostly written by university professors and explores the political, economic and legal possibilities of Seasteads. An overview of the chapters with abstracts can be found here.

If you are interested in Competitive Governance and Seasteading and want to gain insight into the prerequisites for Seasteads to become a long-term success, I can highly recommend this book.

Brexit and the Unforecastability of Demand-Side Recessions

Simon Wren-Lewis claims the Brexit slowdown is about to begin because its negative effect on the economy is no longer masked by unusually strong consumption. Hence, GDP is going to take a hit.

The thing is: all the effects the Brexit vote could conceivably have in the short-run pertain to aggregate demand (AD). Since AD is controlled by the BoE, there is no reason to assume that Brexit will have any short-run consequences on GDP – as I already pointed out immediately after the Brexit vote.

One may argue that at the Zero Lower Bound (ZLB) and under strict inflation targeting, the central bank might lose this control. But since monetary policy in the UK is not even at the ZLB, this theoretical possibility does not apply in the case of post-Brexit Britain.

In general, if the central bank is doing its job properly, any slow-down or reduction of GDP caused by demand-shocks is impossible to predict ahead of time.

Why has this basic fact been ignored by so many economists in the case of Brexit?

Well, most of the economists who have been predicting a negative effect of Brexit on GDP in the short-run believe that Brexit will have a negative effect on the long-run supply side of the British economy. Whether the long-run effect of Brexit will be negative or positive is debatable but taking a pessimistic view is certainly not inherently flawed.

Since economists are human and few humans are immune to the passions involved in political arguments, I guess that, being of the conviction that the long-run effects of Brexit will be negative, these economists have been tempted to loosen their intellectual standards and to sex up their arguments by making gloomy predictions about the short-run as well.

That so many economists have been making these predictions may make them seem respectable. It doesn’t make them well-reasoned or correct.