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The euro was a big mistake, and Greece is paying the price

Greek prime minister Costas Simitis shows US president George W. Bush a new euro coin in 2002, six years before the euro began to destroy the Greek economy.
Greek prime minister Costas Simitis shows US president George W. Bush a new euro coin in 2002, six years before the euro began to destroy the Greek economy.
TIM SLOAN/AFP/Getty Images

The euro, as it currently exists, is an economic disaster. And millions of people in Greece, Spain, and elsewhere in Europe are paying the price.

The Greek unemployment rate of 25 percent is about as high as the worst months of America's Great Depression. Meanwhile, the German economy is booming. The unemployment rate there recently fell below 5 percent, the lowest rate since German unification a quarter century ago.

Now imagine you run the European Central Bank. Your job is to adjust Europe's money supply to avoid both high inflation and high unemployment rates. What do you do?


(Javier Zarracina / Vox)

Basic monetary theory says that when an economy is in a depression as severe as the one in Greece, the solution is aggressive monetary stimulus. So if you wanted to help Greece, you'd want to start printing more money in an effort to lower interest rates, boost demand, and bring down the country's unemployment rate.

On the other hand, if you were just focusing on the German economy, you'd reach the opposite conclusion. Germany's economy is already booming. The economy can't grow much faster than it already is. So more monetary stimulus will just produce inflation. You might even want to cut back to prevent the German economy from overheating.

The problem is that the ECB is responsible for both Greece and Germany — and 17 other countries as well. The right policy for Greece will be a disaster for Germany, and vice versa. Any policy the ECB picks will be either too tight for some European countries or too loose for others.

The ECB is headquartered in Germany and has strong ties to German policymakers. So in practice, it tends to pay more attention to the needs of Germany than other European countries. The result has been an economic disaster for Greece. And not just Greece. Spain's debt problems aren't nearly as bad as Greece's. But its 24 percent unemployment rate is nearly as high, and the Spanish unemployment rate has been above 20 percent for about five years.

The ECB can and should be doing more to support the economies of countries like Greece and Spain. But it's important to note that this isn't a panacea. Printing enough money to get Spain and Greece out of their economic slumps could produce high inflation rates in healthier countries like Germany and Austria. No matter what policy the ECB chooses, someone is going to get harmed.

A common currency needs shared economic institutions

At this point, you're probably wondering why this same problem doesn't plague the United States. Mississippi and Massachusetts have very different economies, yet the Federal Reserve has never faced a situation where the Massachusetts economy was booming while Mississippi was in a deep depression.

I asked Joe Gagnon, an economist at the Peterson Institute for International Economics, why the US doesn't suffer from the kind of problems plaguing the Eurozone right now. He argues that the United States has several economic institutions that help keep the economies of the 50 states in sync with each other.

Common banking policies. US banks are regulated at the federal level, and the Federal Deposit Insurance Corporation guarantees banks in all 50 states. And Gagnon says American regulators don't allow a bank in one state to hold too much of that state's debt. As a result, American states aren't vulnerable to local bank failures the way European countries are. A string of bank failures in Texas would mostly be a problem for the US government, not the government of Texas. Conversely, if an American state has a fiscal crisis, consumers don't need to worry that this will imperil the soundness of local banks.

Common fiscal policies. In the United States, the federal government is responsible for a large share of overall government spending. That's not true in Europe, where the European Union's budget is much smaller than the combined budgets of EU member nations. This means that states are not as vulnerable to macroeconomic swings as European nations are.

"Retirees in Florida are paid out of the US Social Security system, not the Florida social security system," Gagnon says. "So if Florida gets into trouble, the retirees won't lose their benefits."

America's common tax and spending policies help to even out differences in states' economies. When a state is booming, the federal government collects more tax revenue from residents and businesses there. At the same time, demand for some government benefits declines. When a state's economy does poorly, the opposite occurs: tax revenue falls and federal benefit payments increase. These financial flows help to prevent the kind of extreme economic divergence we see in Europe right now.

A common labor market: When some parts of the US have higher unemployment rates than others, people move to states where opportunities are better. Once again, this prevents extreme differences between state unemployment rates, contributing to an integrated national economy.

In theory, all those unemployed Greek people could move to Germany in search of work. But language and cultural barriers make that difficult in practice, and few Greek people have done so.

The euro could work with "ever closer union" — but that won't be easy

As long as the European Union remains a loose confederation of independent nations, the euro will be an economic menace. The currency's problems are by no means limited to Greece. Other countries in the Southern Europe, including Spain, Italy, and Portugal, have been suffering through years of unnecessarily high unemployment due in part to ECB policies.

And similar problems are going to crop up every time the continent experiences an economic downturn. The strongest economies will lobby against strong stimulus due to inflation fears, which will push weaker economies into unnecessarily long and severe recessions. Because most other European countries don't have Greek levels of debt, this may never produce a Greek-style financial crisis. But years of unnecessarily high unemployment is a humanitarian disaster in its own right.

Gagnon argues that the best way to avoid this outcome is the one we use in the United States: deeply integrate the economies of Eurozone nations so that a sharp divergence between European countries becomes impossible.

The EU has been working on proposals to better integrate the European banking system, though it's a long way from completing the job.

Developing a set of EU-wide taxing and spending policies — the counterparts to the US income tax and federally-funded benefits such as Social Security and Medicaid — will be a much bigger challenge. Every year, taxpayers in rich US states effectively subsidize federal benefits for people in poorer states; taxpayers in rich European countries are understandably wary of adopting a similar set of policies in Europe.

True labor market integration will be the hardest challenge of all, because here the problems are about language and culture more than government policy. The EU isn't going to have a shared language any time soon, so workers may never move around the EU as freely as they move around the US today.

European leaders weren't blind to these issue when they set up the euro 16 years ago. But they hoped that the creation of the Eurozone would create momentum to integrate the European economy in other ways. The slogan "ever closer union" captured Europe's aspiration to knit the continent's economy closer together over time.

But progress toward closer union has been slow, and there's reason to doubt whether it will ever be achieved. And if a more integrated Europe is out of reach, then the euro is a terrible idea that will impose needless suffering on millions of people for years to come.

Correction: The original article mistakenly suggested that Denmark was in the Eurozone.