Three Options for the Eurozone

Option 1:  Do massive bailouts of the PIGS, unleashing enormous moral hazard and removing the incentive to address their unsustainable budget policies.  Worst case is that the entire eurozone goes broke.

Option 2:  Let the PIGS collapse, triggering bank runs all over Europe, which leads to a breakup of the eurozone and a severe recession.

Option 3:  Do 4% NGDP targeting, level targeting, from 2008.  Hopefully the various debt/NGDP ratios get more manageable in a few years.

You’ll notice that I do much more blogging on the Fed than the ECB, even though the European situation is currently much worse.  That’s because the euro-crisis doesn’t play to my comparative advantage as a blogger.  It involves issues like moral hazard, game theory, budget theory, one-size-fits-all policy problems, etc, where I have no special expertise.  So I’ll link to some other bloggers who handle these issues better than I can:

1.  Here’s Tyler Cowen explaining why we shouldn’t expect Germany to bail out the PIGS.   Tyler mentioned that the German debt is nearly 80% of GDP, but could have added that the GDP if the PIGS is much bigger than the German GDP.

2.  Here’s Matt Yglesias explaining why the “huge monetary and social costs” of a bit more inflation are tiny compared to the “huge monetary and social costs” of a deflationary collapse of the eurozone.

3.  Nick Rowe explains why a somewhat more expansionary policy would actually make the future value of the euro much less uncertain.

4.  Bill Woolsey argues that the central banks should focus not on being a “lender of last resort,” but rather accommodating changes in the demand for base money in order to keep NGDP growth on target.

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