The Economist focuses on the Nordic region in a special report this week. I scanned the part where it reports on Sweden’s upcoming euro referendum:
Elsewhere this issue, The Economist is not at all impressed with Germany’s performance as the supposed economic engine of the eurozone: “Only partly in jest, The Economist suggests that a better question is not whether Britain should join the currency zone, but whether Germany should leave.” Very interesting reading, and relevant to Sweden’s decision whether to join EMU; does Sweden really want to have the same interest rate required to get the German economy back on its feet?
Once again, Stefan, you raise the terrible specter of European interest rates being too low for Sweden: “does Sweden really want to have the same interest rate required to get the German economy back on its feet?”
Can someone please explain to me what harm is done to a Euro-zone economy if it has lower interest rates than it would have alone? Presumably growth would be higher, and that’s a good thing, right? What’s the dreadful thing which counteracts the benefits of higher growth? Well, there’s inflation — but that would simply make Sweden a more expensive place to visit, since there’s no way that inflation could erode the value of the currency. Would growth above a certain rate increase the likelihood of a boom-bust cycle? Not really, since busts come when interest rates are jacked up to fight inflation, and rates in aggregate would have to stay low if the European economies in general weren’t overheating.
It seems to me that Sweden in EMU would be a bit like London in the UK: prices would rise faster there than in the rest of the currency zone, but mainly because high growth, which is a good thing. No one’s proposing higher UK interest rates to slow down the housing bubble in London.
So why, Stefan, is {higher growth, lower interest rates, higher inflation, currency union} worse than {lower growth, higher interest rates, lower inflation, no currency union}?
Asset bubbles are what happen when you have too much money being created with a too-loose monetary policy and not enough real opportunities to invest. Too-low interest rates by themselves can lead to ultimately greater misery than that caused by too-high ones. The resultant bubble causes huge misallocation of resources and ultimately huge capital loss. The busts have many possible triggers; it doesn’t have to be a jacking-up of interest rates. The effects can take years to unwind and can be real depressions rather than only recessions.
Japan now, the US in the 1930s, and possibly the global economy in 2 years time, are all examples of what can happen if you set your interest rates too low.
Great! So Sweden has the opportunity to mop up the excess liquidity with a nice big government deficit, spending lots of money on social safety nets and whatnot. Use fiscal policy to counteract monetary policy, and everybody’s happy, no?
Well, not if you have a fiscal pact to restrict excessive government deficits. Plus if a really mean deflation takes hold, you have to spend tax money on ways you know that will lead to consumption or productivity improvements. Social spending doesn’t help if you just put money into the hands of people who won’t spend or invest it.
But I was talking theory anyway. If you’ve got a major asset bubble due to excess liquidity (say housing, or stocks) that is growing, government spending doesn’t mop up liquidity but adds to it, creating more money and liquidity, exacerbating the readjustment process that is to follow. More doom ensues. It’s like, hey you’re hideously drunk at a party; want some coke?