Interest Rates and the Euro
After the introduction of the euro, many peripheral countries in the euro area experienced a major credit boom. The reason for this was that these countries previously had “soft” currencies, this is to say, they regularly devalued their currencies instead of implementing economic reform.
Devaluation is the easy way out for policymakers after all. The supposed “advantages” of currency devaluation, illusory, misleading and fleeting as they are, are always experienced as the first effect. The disadvantages – which dwarf all the so-called advantages – are only becoming visible at a later stage, by which time most people are no longer able to properly assess the cause-effect vector.
This failure to understand cause and effect in economics is widespread. Unfortunately, one group among which it is widespread are economists. Looking at the assertions made by many of today's most prominent economists, we are often struck by how superficial they appear, especially with respect to monetary debasement.
Frédéric Bastiat: a classical “proto-Austrian” economist whose writings remain highly pertinent.
Photo via Wikimedia Commons
As Frédéric Bastiat pointed out more than 170 years ago, this is precisely what differentiates good from bad economists:
“There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.
Yet this difference is tremendous; for it almost always happens that when the immediate consequence is favorable, the later consequences are disastrous, and vice versa.”
(italics in original)
Favorable immediate effects followed by disastrous later consequences is incidentally an excellent characterization of the policy of monetary debasement and devaluation.
Given that countries like Spain once were well-known for their devaluation policies, investors demanded relatively high interest rates before committing funds to fixed-income securities issued by such countries. After the introduction of the euro, it became impossible for national governments to unilaterally devalue and this price premium disappeared from interest rates.
