May 24, 2010
Almost the whole of the U.S. economics profession missed the build-up of the housing bubble that caused the Great Recession. So, it may surprise many non-economists to learn that for the last two decades U.S. economists have used standard tools to predict many of the economic problems currently facing the European Union.
The January 2010 edition of the Econ Journal Watch contains a fascinating review of U.S. economic research from the late 1980s through the early 2000s on the likely outcome of a single European currency. The authors of the paper –Swedish economist Lars Jonung and Irish economist Eoin Drea examined about 170 publications written between 1989 and 2002 by U.S. economists in academia and at the Federal Reserve.
The title of the new paper, which does a remarkable job of summarizing its main findings, is drawn from a quotation from the late MIT economist Rudiger Dornbusch. In 2001, Dornbusch described the U.S. economic profession’s views on the euro as generally taking one of three positions: “It can’t happen”; “It’s a bad idea”; and “It can’t last.”
According to Jonung and Drea: “The main finding of our survey is that US academic economists were mostly skeptical of the single currency in the 1990s.” Their main concern surrounded the idea that the euro area did not fulfill the conditions for what economists call an “optimal currency area“, among other reasons, because the euro area does not have the kind of central government that can smooth out differences in economic performance across subregions of the currency area. This is, of course, exactly what is at the core of the problems facing the European Union and the euro area right now.
The paper is a very useful review of what U.S. economists were thinking of the euro before, during, and after its creation. But, the timing –the paper was released just before the euro was forced to confront the Greek debt crisis– could not have been less kind to Jonung and Drea. In their piece, they take the view that the bulk of U.S. economists got the euro wrong: “By now, the euro has existed for more than a decade. The pessimistic forecasts and scenarios of the U.S. academic economists in the 1990s have not materialized. The euro is well established. It has not created political turmoil in Europe, and it has fostered integration of financial, labor and commodity markets within the euro area.” (p. 34) After recent events, these guys must now be feeling a bit like the U.S. economists who were denying the housing bubble back in early 2007.
Unfortunately for residents of the euro area, it looks like the U.S. economics profession may have made the right call on this one.
