Wednesday, January 5, 2011

Why the Eurozone is not an optimal currency area

What should the ECB do? Should it increase interest rates or leave them where they are?

The property market in Vienna strongly suggests that it is time for a rate increase. Home prices in the Austrian capital jumped 10 percent this year. Property price inflation is outstripping income growth; a sure sign of a bubble. Viennese property speculators need a slap in the face to bring them back to reality. Only a hefty rate hike can do that.

Dublin, on the other hand, is a housing market Chernobyl. Prices in the Irish capital are down 22 percent this year and almost 50 percent since the property bubble peak.. Here the situation is quite different. Everyone in Ireland apart from the parish priest is on a Euro-tracker mortgage. Somewhat surprisingly, Irish mortgage holders have continued to service their debts. The mortgage default rates is comparatively low. A rate hike would probably push many homeowners over the edge. This could generate a further round of banking losses.

More generally, inflation rates across Europe are picking up. The post-crisis surge of liquidity is feeding through into the real economy. Unfortunately, the Eurozone is travelling down two quite separate tracks, as the housing market of Dublin and Vienna amply demonstrate.

Rock? Hard place?

1 comment:

  1. I have to disagree with your central contention about the supposed ills of the 'one size fits all' Euro.

    Money has been used by the authorities as a blunt policy tool, to disasterous effect over many years, yet the private sector, miraculously, adapts to the carnage, and soldiers on. The idea that authorities should now 'slap the face' one part of the private sector, how ever much we are worried, is unfortunate.

    The problems of eurpoe do not come down to which fiduciary media we choose (or are allowed) to use as a means of exchange. The actual problem is twofold;

    1) Is money sound, thus allowing rational choices by economic actors, based upon a stable amount of money relative to goods and services (or even, just a stable amount of money, full stop). Is the rate of interest charged represnetative of the time preference choices of those economic actors?

    2) How much are the authorities interfering in the natural flows of capital allocation.

    I would suggest that these two factors are of immense importance, and lie at the heart of Vienna's, Ireland's, Eurpoe's and indeed the world's troubles.