It’s rare to take on Paul Krugman in an argument and win, and I agree with him most of the time anyway (these two facts are correlated!). So, this is the first time, and will probably be the last, when I can claim a win in such an argument.
Krugman has long criticised the eurozone on the grounds that it is not an optimal currency area and that the European Central Bank must therefore pursue an unsatisfactory “one size fits all” policy, too contractionary for economies that are doing badly and too expansionary for those that are doing well. Back in February, I argued that in fact ECB policy was “One size fits nobody” and that even Germany was vulnerable to its contractionary effects.
The latest statistics suggest that German growth was already stalling then. Today, Krugman is also pointing to a “one size fits none” policy.
At this point, it’s time for a suit of clothes, and that means a new tailor. And, in that respect, the bad news may have a silver lining.
The silver lining can be seen in today’s New York Times, which reports new proposals from Merkel and Sarkozy, pushing in the direction of fiscal union. They refer to a requirement for a “golden rule” balanced budget requirement to be enshrined in EU member constitutions. Assuming that the “golden rule” refers the standard interpretation of “budget balance over the cycle”, and not the crazy US Republican proposal for annually balanced budgets, this is, in essence the “hard Keynesianism” Henry Farrell and I have been pushing for some time. I haven’t yet read the fine print, but it’s hard to see how this proposal can be made acceptable to the periphery without an accompanying shift away from hardline austerity and monetary contraction in the short run. That means, in particular, overriding the opposition of the European Central Bank.
At the personal level, the impending departure of Jean-Claude Trichet provides the ECB with an ideal opportunity to dump his failed policies. His designated successor Mario Draghi (ex GS, and widely regarded as a Trichet clone) does not look promising, but he has both an ideal opportunity and some strong incentives to make a break with the past.