A year ago, I wondered whether the euro would act like the gold standard during the Great Depression. It is one of my longest blog posts ever and cannot be summarized in a few sentences. Or, maybe it can, but at least I would need considerable time in order to do that. Since I still like that post, though, I would recommend to read it whole.
We describe in this essay why the gold standard and the euro are extreme forms of fixed exchange rates, and how these policies had their most potent effects in the worst peaceful economic periods in modern times. While we are lucky to have avoided another catastrophe like the Great Depression in 2008-9, mainly by virtue of policy makers’ aggressive use of monetary and fiscal stimuli, the world economy still is experiencing many difficulties. As in the Great Depression, this second round of problems stems from the prevalence of fixed exchange rates. Fixed exchange rates facilitate business and communication in good times but intensify problems when times are bad.
Well, although I can forget about publishing my post in paper form, I am quite happy that people like Eichengreen and Temin attacked this issue. Having looked through the paper in fast-forward, I think I will agree with much of it. The price levels are wrong and their stickiness is a drag on the world economy since it slows down adjustment. In the next days, I will post a BoP accounting view of the Irish situation which should explain this in more detail. If you can’t wait, read my old post from November 2009.