The euro is still far too strong

The title of this post does not refer to the exchange rate, the importance of which is overrated.

Tyler Cowen has a new post on the euro.  Here’s his conclusion:

All in all, the weaker euro is likely to prove a net benefit to the eurozone, all the more so if monetary policy can drum up some expansionary domestic benefits above and beyond the exchange rate effect.  Still, if you deliberately engineer a depreciation of your currency out of weakness and desperation, the long-run benefits usually don’t match up to that immediate feeling of short-run juice.

This is correct.  There are many examples of Latin American or Mediterranean countries devaluing their currency, and merely ending up with higher inflation in the long run.  But it’s also important to point out that the euro is still far too strong. Unfortunately there is no single measure of the strength of a currency, but surely it is more meaningful to talk about it’s ability to purchase a basket of all goods and services, as compared to its ability to purchase a pound of zinc, a share of Apple stock, a US dollar, an Australian dollar, or a Zimbabwean dollar.  I’d argue that a still better measure would be the fraction of a year’s eurozone NGDP that can be bought with a single euro.

In any case, whether you use the price level or NGDP as your metric, the euro is far too strong.  So while there are many examples throughout history of countries debasing their currency, the eurozone is not currently one of those examples.

PS.  If in fact the ECB has engineered a weaker euro in the forex markets, then ipso facto it has engineered “some expansionary domestic benefits above and beyond the exchange rate effect” relative to a tighter monetary policy stance. When using monetary policy, you can’t have one without the other.

Update:  Marcus Nunes has a related post on the yen.  Yes, there are actually people claiming the yen is too weak (not Marcus!)  Isn’t the yen right up there with the Swiss franc, vying for the title of the strongest fiat currency in the history of the world?


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14 Responses to “The euro is still far too strong”

  1. Gravatar of Tyler Cowen Tyler Cowen
    12. March 2015 at 10:49

    I am not saying I disagree, but this is a funny position to take, and a funny imaginary PPP/ngdp standard to invoke, for a *market* monetarist…!

  2. Gravatar of Vivian Darkbloom Vivian Darkbloom
    12. March 2015 at 10:56

    Mr. Cowen makes a very good point.

  3. Gravatar of TravisV TravisV
    12. March 2015 at 10:57

    This was another great recent post providing perspective to Cowen:

    http://www.themoneyillusion.com/?p=28762

  4. Gravatar of ssumner ssumner
    12. March 2015 at 10:59

    Tyler, I’m not saying the exchange rate is in any sense “wrong”, given the monetary policy. Rather I’m saying the value of the euro as determined by that monetary policy is too high relative to the value that would produce a good macroeconomic outcome. Money needs to be looser in the eurozone. So there’s no contradiction with my view that markets are efficient–at least none that I can see.

  5. Gravatar of Derivs Derivs
    12. March 2015 at 11:18

    ” I’d argue that a still better measure would be the fraction of a year’s eurozone NGDP that can be bought with a single euro.”

    Agree completely.

  6. Gravatar of am am
    12. March 2015 at 12:26

    The Zimbabwe dollar is back – at least in the form of some bond coins for change. The value is one to one with the US dollar. So in Zimbabwe one domestic dollar can purchase exactly the same as one US dollar. I suppose if you went into a garage to buy 50 litres with the new coins then they might not be accepted so its true value would be seen as not one to one.

    https://www.newsday.co.zw/2015/02/04/mangudya-appeals-mps-assist-disseminating-information-bond-coins

    But not very relevant to the post – I admit.

  7. Gravatar of Mark Mark
    12. March 2015 at 12:59

    “Still, if you deliberately engineer a depreciation of your currency out of weakness and desperation”.

    I don’t know why Tyler would make this point given how long the ECB has undershot their inflation mandate.

    My inference is Tyler revealed an underlying ‘harder’-money bias.

  8. Gravatar of ssumner ssumner
    12. March 2015 at 13:01

    Mark, It wasn’t clear to me by the “if” qualification that he was referring to the ECB. But that’s one reason I did this post, to clarify things.

  9. Gravatar of Vaidas Urba Vaidas Urba
    12. March 2015 at 15:17

    Tim Duy: http://economistsview.typepad.com/timduy/2015/03/will-the-dollar-impact-us-growth.html

  10. Gravatar of Mike Griswold Mike Griswold
    12. March 2015 at 17:14

    Scott,

    I think I’m missing your point, but isn’t the fraction of Eurozone NGDP that can be bought with one Euro 1/NGDP by construction? Is this a roundabout way of saying you believe Eurozone NGDP is too low? Sorry to be obtuse.

    Mike

  11. Gravatar of Major.Freedom Major.Freedom
    12. March 2015 at 17:18

    No market monetarist has yet explained why a wage earner would accept death from starvation, and why an employer would sacrifice profits, all in the name of refusing to lower wage rates 10% or 20% on any given day that a wage contract can be negotiated.

    If you can understand why eliminating welfare will lead to a boost in employment, then you should be able to understand why eliminating inflation will lead to a further boost in employment.

  12. Gravatar of Major.Freedom Major.Freedom
    12. March 2015 at 17:31

    All in all, the weaker euro is likely to prove a net benefit to the eurozone, all the more so if monetary policy can drum up some expansionary domestic benefits above and beyond the exchange rate effect. Still, if you deliberately engineer a depreciation of your currency out of weakness and desperation, the long-run benefits usually don’t match up to that immediate feeling of short-run juice.

    “This is correct.”

    No, that is incorrect. Europe has been, and continues to be, weakened by inflation. The reason why so many more Euros need to be printed to avoid correction is precisely because the EU economy has been too distorted by previous inflation. More inflation will only make the problems worse.

    The costs Cowen refers to are costs he is deliberately minimizing because of an inability to understand the law of opportunity costs, and the market process. He drank the kool-aid.

  13. Gravatar of Ray Lopez Ray Lopez
    12. March 2015 at 19:46

    I died and went to heaven with this post. If a fellow economist–and one on the same team as Sumner–cannot understand Sumner, what hope is there for the rest of us? :-)

    Of interest to those of us who actually are trying to learn something reading this blog (hard to do, I know…): http://www.economicshelp.org/macroeconomics/exchangerate/factors-influencing/

  14. Gravatar of ssumner ssumner
    13. March 2015 at 04:25

    Thanks Vaidas.

    Mike, Yes.

    Ray, There is no hope for you. First time you got something right.

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