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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About Scott Sumner 492 Articles

Affiliation: Bentley University

Scott Sumner has taught economics at Bentley University for the past 27 years.

He earned a BA in economics at Wisconsin and a PhD at University of Chicago.

Professor Sumner's current research topics include monetary policy targets and the Great Depression. His areas of interest are macroeconomics, monetary theory and policy, and history of economic thought.

Professor Sumner has published articles in the Journal of Political Economy, the Journal of Money, Credit and Banking, and the Bulletin of Economic Research.

Visit: TheMoneyIllusion

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