Supply-Side Notes 6-9-12

An interview with Robert Mundell:

Robert Mundell: Euro is here to stay

The euro has ‘passed its youth with flying colours,’ is a world currency par excellence and has great future as an international reserve asset

FP COMMENT:Paul Krugman and others are now claiming that your original paper, “The Theory of Optimum Currency Areas,” required labour mobility and fiscal union. Europe didn’t have either; therefore the euro was a mistake.

MUNDELL: My argument for Optimal Currency Areas said nothing about fiscal union. Very few countries in the world have a fiscal union. It would be almost impossible for a large country to have a complete fiscal union. Canada and the United States do not. In the United States, the central government spends maybe 22% of GDP while total government spending is about 37%. Every country’s fiscal structure is different, depending on the way in which spending and taxes are divided among the federal government, the state or provincial government and the municipalities.

A fiscal union is not a prerequisite for a monetary union. The argument that monetary unions require fiscal unions is a recent idea based on new functions of government to give assistance to specific economic groups hit by asymmetric shocks. This kind of specific relief to hard-hit segments would be better carried out at the federal government level, as in the U.S. or Canada, rather than the local level. But it does not require fiscal union in any comprehensive sense.

Historically, monetary unions have been established in ancient empires and nation states without regard to fiscal union. Even after the U.S. consolidated state debts into a national debt in 1792, states were sovereign with respect to debts and deficits. When several defaulted in the 1840s they were not bailed out and nobody imagined that the problem had anything to do with the U.S. monetary union.

This is not to say that Europe might not be better off with a redistribution of functions from the nation-state to the “federal” level, including defense and social security unification. But if these shifts of responsibility are made along with corresponding shifts in the powers of taxation, they should be made on grounds of efficiency and economic justice, not on grounds that they are necessary for monetary union.

Read the entire interview here