The sustainability of the single currency: Different rates and different fates

IN A new paper*, Kevin O’Rourke and Alan Taylor compare the American and euro-area currency zones. Optimists argue that if a big, diverse economy like America manages to have a single currency, Europe should too. Optimists, if not already disillusioned, will find more to dislike in this new analysis.The trouble with a large currency area is that economic conditions can very widely within. A central bank struggling to accommodate all regions with just a single policy may find that some places inevitably run hot, experiencing tight labour markets and inflation, while others are nearer a slump. For a currency area to survive, then, one has to hope that individual regions never diverge too much in their economic fortunes. Mssrs O’Rourke and Taylor compare European and American performance on this score. They first calculate the “desired” policy rate for each area over time. To do this, inflation and unemployment are taken into consideration. They then compare the desired policy rate to the actual policy rate that was implemented at that time.For the sample of American regions, the difference between the desired and the actual policy rates was usually between 0 and 200 basis points. In other words, many areas received an interest rate that was perfect for their economy, and almost none received one that was more than two percentage points off.The euro area is a different …

Link to article: www.economist.com/blogs/freeexchange/2013/08/sustainability-single-currency?fsrc=rss

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