How did the Irish government come up with the plans that they did? They borrowed a lot of money in euros and used it to pay off the Germans in Euros. This wasn’t the whole story, as the head of a leading German think tank, Wolfgang Schauble, pointed out in a recent interview, but it was a big part of it. Currency devaluation is an unusual tool of national government, and probably the most expensive one, at least relative to the national budget. When it’s used to pay off debt, it increases economic costs relative to GDP, so that the cost of doing so becomes much more relative than it otherwise would be. Currency devaluation can be effective, in a very limited sense, if you have some production that can’t move because of a closed market, or if it is required to pay down part of the national debt. But it can’t be deployed in a consistent way unless you come up with some way to adjust the exchange rate. If you want to be a competitive nation, you need to look at your exchange rate. It is also a matter of sentiment, and not just of the state of the economy. You need a sufficiently deep cultural sentiment to accept such a gambit. For example, a relatively prosperous country such as Germany is more likely to bond out of such a move than a much poorer country such as Ireland. Germany’s willingness to intervene in monetary policy to weaken the euro was part of the reasons why it wasn’t immune to the recent economic crisis. In the end, however, you have to act in the face of economic weakness — without resorting to deflationary remedies (or, as we’ve seen so much lately, fiscal policies). None of that, of course, explains why the Irish government decided to do this. How did they arrive at their decision? It would help, obviously, if they had taken some steps to promote growth in the coming years. Maybe they should expand government investment more, or consider some basic deregulation of the economy. But whatever steps they took to strengthen the economy, I doubt that would have prevented them from actually doing what they did. Under the rules of a currency union, the government doesn’t have the right to respond in kind to bad economic news with fiscal stimulus. All the talks about European integration were based on the idea that common policy coherence would come from allowing countries to behave in accord with their interests — and within those interests. This principle has been invoked, to great effect, in the eurozone itself. All central banks that buy sovereign debt for use in financing eurozone sovereigns must do so precisely because they agree to do so in accord with the Lisbon Treaty. The European Stability Mechanism is structured precisely so that its interventions, when needed, can be relatively limited in scale, to avoid the possibility of an uncontrollable credit boom, or a rush to private creditors. And so on. The thought is that the eurozone will be successful as a union only if it has a coherence — one that is derived from the idea that the policy decisions of individual countries are best taken at the national level and not transferred onto the European level. The German experience with the euro’s introduction so far strongly suggests that the opposite is true: that it is the policy of central banks to decide what is in the national interest and transfer it to the European level, on pain of loss of national sovereignty. Governments don’t have a great incentive to undermine the euro project. To do so is to write off most of the gains from unification that have been enjoyed by other parts of the euro bloc. It is to open up the way for the neighboring countries that refuse to do so to negotiate their own exits from the project. There is, however, one way to weaken the euro — a little cheap devaluation — without risking a breakup of the euro area: to bring back the Pound Sterling. This would force British exporters to drop their prices, possibly creating further growth opportunities in eurozone countries. It would give Irish exporters access to vast markets just outside the euro zone. It would be a clear signal to the German people that there is another way of thinking about the crisis. If the Irish government is willing to take such risks, as I suggest, let them show us which of the euro’s virtues they consider to be stronger than the harm.
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