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Are All European Policymakers Insane?

Matthew Yglesias:

Yglesias » The Latvian Catastrophe: Klaus Regling, chief executive of the European Financial Stability Facility, wants you to know that monetary union without fiscal integration is workable after all and he offers, as an example, Latvia:

Latvia which has a currency pegged to the euro, testifies to the success of this policy. Contrary to commentators who predicted disaster for Latvia early last year unless it gave up its hard peg – in line with advice from the commission – it did not devalue its exchange rate. A real effective devaluation was achieved through severe cuts in nominal income. Today its economy is growing again. Those outside “experts”, who always seem to know what is good for Europe, should take note.

So to be clear about this, the Latvian economy suffered a 4.2 percent contraction in 2008. By way of comparison, in the horrible year of 2009 the US economy contracted 2.44 percent. So that was a very bad recession, much worse than the American recession. At this point, so called “outside ‘experts’” predicted disaster for Latvia in early 2009 unless it devalued its exchange rate. Latvia declined to devalue and its GDP shrunk 18 percent! That’s the disaster right there. Overall GDP growth for 2010 is forecast to be slightly negative again. So, yes, Latvia has returned the growth. But the toll was terrifyingly high.

As ever, there were some “real” shocks involved in this. Some loss in Latvian living standards was inevitable and unavoidable. But the unemployment rate in Latvia is nearly 20 percent. That means a great many able-bodied adults are simply not working, not producing any goods and services for market consumption. That represents a vast loss of living standards that could have been largely avoided in a floating exchange rate regime.

To suggest that this is some kind of success story that illustrates the underlying workability of the system is horrifying.