Posted Wednesday, July 11, 2012, at 2:08 PM
Photograph by Thomas Coex/AFP/Getty Images.
Countries generally only undergo a sharp devaluation in the value of their currency when something's gone badly wrong. That can make it difficult to distinguish, statistically speaking, from cases in which the devaluation per se was damaging and when the devaluation helped cushion the blow. But according to Joe Gagnon's 2010 paper "Currency Crashes in Industrial Countries: What Determines Good and Bad Outcomes?" a currency devaluation is almost never a cause of bad outcomes unless it's simply one part of a broader mosaic of excessive inflation:
Sharp exchange rate depreciations, or currency crashes, are associated with poor economic outcomes in industrial countries only when they are caused by inflationary macroeconomic policies. Moreover, the poor outcomes are attributable to inflationary policies in general and not the currency crashes in particular. On the other hand, crashes caused by rising unemployment or external deficits have always been followed by solid economic growth, rising asset prices and stable or falling inflation rates.
Tying this back to the eurozone crisis, one of the main economic policy objectives of elites in Italy and Spain was to commit their countries to a lower-inflation course by removing debt-monetization and currency devaluation as a policy option. And this has, indeed, worked in holding Spain and Italy to much lower inflation trajectories. But the cost is that they've abandoned the inflationary course in a way that's cut off the possibility of responding to rising unemployment or external deficits with currency devaluation. And right now that's proving exceptionally harmful. And it's not just high unemployment in the short term. Even pre-crisis, Spain was a less-educated, less-skilled, less-proserous country than Germany. Putting it through the ringer of a years-long span of 20-plus percent unemployment is going to lead to de-skilling of the workforce and sharply discourage the accumulation of capital goods while failing to properly reward productivity enhancing management innovations.