Saturday, 20 March 2010

Portugal should not abandon the Euro

   Alvaro's post suggests that there is overwhelming evidence that the Euro is responsible for the current situation in Portugal. Alvaro, as well as some of the commentators to his post, suggest Portuguese politicians may envision abandoning the Euro if stagnation persists.
   I am not sure I agree with the statement about the evidence. The evidence that I am aware of shows that common currency unions, such as the euro zone, tend to produce two main positive effects. First, they lower inflation. Second, they promote trade (by reducing transaction costs). The latter effect appears to be large and significant (see Frankel and Rose, QJE, 2002).
   True, common currency areas prevent the use of domestic currency devaluation in adjusting to asymmetric shocks. However, do we really want to go back to the times when Portugal had such flexibility? Let's not forget Portugal had very weak monetary institutions, leading in particular to high inflation. One of the key benefits of the Euro was to allow Portugal to benefit from top quality monetary institutions. This has been invaluable to Portugal, we should not go back.
   Moreover, currency devaluation is like a balloon of fresh air. Sooner rather than later, the fresh air will run out. If there are persistent problems underlying the stagnation, devaluating won't help; which means, I would not assign the blame to the Euro. I believe we do need to look for the deeper reasons of the Portuguese stagnation; I offered a couple of conjectures in a previous post.

2 comments:

  1. I believe a deeper reason that may be behind the Portuguese economic problems is that a blog about Portuguese economy is written in English.

    Yes, you may argue that this is useful to potential foreign readers interested in our problems. I prefer the view that Portuguese people do need enlightenment about some of the problems that affect their daily lives.
    This blog is made by some really good economists from the better Portuguese faculties, and its a shame that you don't use that status to provide the discussion we can't find anywhere in this country.

    Regarding the discussion about the Euro, (the possibility for) devaluation will not help in what you consider our deeper problems, for sure, but it would help us in the 10-20 years that would take us to solve those problems if we start tackling them right now, which is not the case.
    Companies face tough days, and you can't really think about the long term. If we concentrate in having good education, and prepared and productive people, without focusing on keeping the firms that will provide employment to those people when they are ready to work alive, we will never even reach that state.

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  2. I do not really understand the last comment. Regarding the English language discussion, this is a blog where its authors can write in whatever language they want. This blog's objective is to discuss the issues of our (apparently) single situation, without restraining the participants only to Portuguese speakers. As you are saying, some of the blog contributors are really good economists from the best Portuguese universities, but, as you probably also know, there are also very good non-Portuguese economists that are part of the universities' international faculty body that do not speak Portuguese. Do you want to keep them from giving their comments or suggestions? There are also very good researchers abroad that do not speak Portuguese but are highly qualified and you want to exclude them from helping us? I do not believe that would be a reasonable thing to do...

    And if you really think that this blog should be in portuguese why did you write your comment in English? If you had read the first post ever you would know that the contributors welcome everyone to comment, no matters if it is in English or in Portuguese. About the contributors to this blog, I frequently see most of them on the television or writing articles in the newspapers. Aren't they doing their share in terms of enlightening the Portuguese people?

    Finally regarding the Euro, I believe that leaving the EMU would not help us in the long-run. And in the Short-Run, even if devaluation could increase our GDP for a short period, we would possible return to having very weak monetary institutions, bringing back high inflation and the possibility of suffering a speculative attack. Another effect is that trade with the members of the EMU could decrease a lot (and some of our major trade partners are within the EMU), due to the appearance of new transaction costs, as have been said above. On the last post I believe that you are using a "firm-side" approach. In my point of view, the incentives that should be given to firms should be related to tax issues, even though that our exchange rate affects our competitiveness. Do you really believe that we should not care about the long-term? I believe that one of the reasons that are behind Portugal's serious situation is exactly that we have not cared enough about the future over the last 30 years.

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