Decoupling: One expensive euro: [L]essons learned from the [Great] Depression… a nasty feedback loop…. [H]eavily indebted economies… faced pressure to begin running large current account surpluses in order to pay back loans. The gold standard prevented devaluation, however, and instead forced countries into import-crushing downturns to generate the needed surplus. Other economies, unwilling to allow their current accounts to swing to large deficits lest they suffer gold outflows, tightened monetary policy in response…. At the same time, economic downturns squeezed banks, leading to waves of bank failures…. Capital outflows placed pressure on central banks to raise interest rates (to hang on to gold reserves), which increased the odds of bank failure, which accelerated the pace of outflows. The result was economic collapse and catastrophe, broken only by the end of the gold standard and which even then left political chaos in its wake….
[T]oday's policymakers do know more about how not to fight crises than their 1930s counterparts. That difference in knowledge is the reason the euro area is falling hundreds of billions short of an achievable output path rather then several trillion. And so I think there might be a different and more effective way to describe what's happening in Europe.
Let's say that… the gap between a Depression-like path for America's economy and its actual path represents a gain attributable to the macroeconomic knowledge attained since the 1930s. I, like many others, think that the American economy could be doing even better—could in fact be operating at estimated potential. But policymakers lack an intellectual consensus on how to get there. Thus, intellectual potential.
Europe is falling short of intellectual potential. This shortfall isn't "structural" in the usual sense; it has only emerged over the past two years or so. It could be due to a "Great Forgetting" in the euro area—a systematic loss of macroeconomic knowledge isolated to one corner of the global economy—but that seems unlikely, and the European Central Bank's refusal to give in to liquidationism suggests the lessons of the Depression have not leaked out of Mario Draghi's brain.
No, the gap instead corresponds to the euro area's failure to implement an institutional framework capable of delivering intellectual potential…. The gap between the euro zone and America is the counterfactual, the but-for path, that helps illustrate just how damaging the single currency has been. Leave the euro area and you may not immediately spring back to that alternate path, leaders around the periphery may think, but at least you'll stop sinking, and you can sell your wares to the world's healthy economies at a steep discount relative to your neighbours.
I had been surprised at how long euro-area residents seemed content to suffer through the continent's economic mess. But maybe I shouldn't have been; until recently, it wasn't obvious that other large, rich economies could manage much better. Now it is, and it will become more obvious every quarter. Perhaps the American example will motivate euro-area leaders to change course. If not, the temptation to abandon a sinking ship will only grow.
Unless, of course, the austerity of the Republican Party clubs America down onto a European trajectory...