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Eurozone’s last straw: a strong euro

In Europe

In the current environment of huge indebtedness and low inflation, with sizeable unspent resources, a strong euro adds insult to injury.

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The almighty Bundesbank has sent out a warning about an impending currency exchange war. The euro has appreciated in excess against the US dollar and other currencies, which could threaten the eurozone’s exports–although one is tempted to believe that the German central bank worries particularly about German exports.

In the current environment of huge indebtedness and low inflation, with sizeable unspent resources, a strong euro adds insult to injury in countries like Spain, whose economy struggles to keep merely afloat: there are no signs of recovery and small and medium businesses shut down in scary numbers. Data about unemployment and retail sales are equally frightening, as shown above.

If the euro’s exchange rate is to calm down in the current asphyxiating economic conditions, money supply must expand. Menzie David Chinn, professor of public affairs and economics at the University of Wisconsin–Madison, explains it here:

“Suppose Country A conducts expansionary monetary policy that (for the sake of argument) would result in a weaker exchange rate and a higher price level (say by 10%).Now suppose Country B seeks to prevent an appreciation of its own currency against Currency A; it could undertake a commensurate expansionary monetary expansion (that would result in a 10% price increase). In the end, the nominal exchange rate is unchanged, but the price level in both countries is higher. This might seem like a zero sum game – but I would say that in fact the world benefits if the price level is too low. That is, as Jeff Frieden and I have argued, higher inflation is going to be helpful in shrinking debt ratios and facilitating real wage adjustment. (That being said, the current measures (aside from extended guidance) do not seem likely to have large impact on inflation, except to the extent that output is increased and prices rise via the Phillips curve.)”

Inflation, under certain circumstances, can become a good friend to reduce the volume of debt. Unfortunately, we have fallen pray of eurocrats and our own local bureaucrats, who long ago lost sight of the public interest. It’s time they stop blaming the US and follow their example, instead.

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