Monetary policy without the euro
Daniel Hannan is blaming the euro for Ireland’s woes. This raises a paradox. Hannan’s argument seems reasonable. Had Ireland stayed out of the euro, the Central Bank of Ireland would have been free to run a tighter monetary policy, and this would have prevented the boom in credit and house prices, the ending of which destroyed the banks and crippled the economy.There is, however, an obvious counter-argument to this. Central banks which have been free to set monetary policy without regard to external factors have not succeeded in avoiding bubbles in credit and asset prices - just look at the Fed. An independent national monetary policy - even assuming one is feasible for a small open economy such as Ireland - is no guarantee of avoiding financial crises.Why? There are, roughly speaking, three possible reasons:1. The Fed - under both Greenspan and Bernanke until at least 2008 - believed markets were rational and so underweighted the danger of asset prices bubbles. On this view, monetary policy failure was a temporary and corrigible error.2. Central bankers’ reputations depend disproportionately upon what bankers think of them; in most times, the ordinary man in the street doesn’t give a thought to central banking. This gives central bankers an interest in erring on the side of low interest rates, because investment banks love cheap and easy money. This is why Bob Woodward could get away with describing Greenspan as a “maestro.”3. It’s just impossible for central bankers to spot bubbles, especially in the presence of the sort of supply-side changes Ireland experienced in the 00s, because centralized experts cannot know better than even imperfect markets. Which brings me to my paradox. If I were a rightist, I’d have more sympathy with (2) or (3) than (1) - in fact, I do. But if this is the case, the value of monetary policy autonomy is low, in which case the argument for Ireland having stayed out of the euro becomes weaker. To believe that Ireland could have avoided a bubble by staying out of the euro requires one to believe that centralized policy can reliably out-perform markets and prevent bubbles. Which is an odd thing for a right-winger to believe.