Euro Fetters?

Although it can be alarming how relevant the Great Depression sometimes seems today, it is reassuring that the policy response has reflected the lessons learned (at least in the US). Monetary policy has been very aggressive, partly because Ben Bernanke understands those lessons as well as anyone, and because the Fed is not limited by gold standard the way central banks were in the 1930's.

However, the Euro may be playing a role similar to the gold standard in constraining Ireland from responding appropriately to its very sharp recession, according to Ambrose Evans-Pritchard:

If Ireland still controlled the levers of economic policy, it would have slashed interest rates to near zero to prevent a property collapse from destroying the banking system.

The Irish central bank would be a founder member of the "money printing" club, leading the way towards quantitative easing a l'outrance.

Irish bond yields would not be soaring into the stratosphere. The central bank would be crushing the yields with a sledge-hammer, just as the Fed and the Bank of England are crushing yields on US Treasuries and gilts.

Dublin would be smiling quietly as the Irish exchange rate fell a third to reflect the reality of trade ties to Sterling and the dollar zone.

It would not be tossing away its low-tax Celtic model to scrape together a few tax farthings – supposedly to stop the budget deficit exploding to 13pc of GDP this year, or 18pc says Barclays Capital. If the tax raises were designed to placate rating agencies, they made no difference. Fitch promptly booted Ireland from the AAA club anyway.

Above all, Ireland would not be the lone member of the OECD club to compound its disaster by slashing child benefit and youth unemployment along with everything else in last week's "budget from Hell".

Depression buffs will note the parallel with Britain's infamous budget in September 1931, when Phillip Snowden cut the dole and child allowance to uphold the deflation orthodoxies of the Gold Standard – though in that case the flinty Pennine rather liked hair-shirts for their own sake.

Though few had any inkling at the time, Snowden's austerity drive would soon push British society over the edge. It set off a mutiny – a Royal Navy mutiny at Invergordon over pay cuts, in turn triggering a run on sterling. The pound was forced off Gold within days. Irish deliverance from EMU will not be so easy.

Brian Lenihan, Ireland's finance minister, said the economy would contract 8pc this year on top of the terrifying 7.1pc drop in the final quarter of last year.

But what caught my ear was his throw-away comment that prices would fall 4pc, which is to admit that Ireland is spiralling into the most extreme deflation in any country since the early 1930s. Or put another way, "real" interest rates are rocketing.

This is torture for a debtors' economy. You can survive deflation; you can survive debt; but Irving Fisher taught us in his 1933 treatise "Debt Deflation causes of Great Depressions" that the two together will eat you alive.

The downside of membership in a common currency like the Euro is giving up monetary policy independence. For economies which tend to move together, a common monetary policy would work reasonably well. That is, an "optimum currency area" would exist. Evans-Pritchard is essentially making the case that Ireland and Germany (the largest Euro economy) are not an optimum currency area. He argues that the Irish boom was inflated by the European Central Bank keeping rates low earlier in the decade when the German economy was sluggish:

[Ireland] was betrayed again by the European Central Bank, which opened the monetary floodgates early this decade to nurse Germany through a slump, holding rates at 2pc until late 2005, despite flagrant breach of the ECB's own M3 money targets. Fast-growing Ireland and the Club Med over-heaters were sacrificed to help Germany. They were left to cope with credit bubbles as best they could.

And now, when the boom collapses, it is forced into overly-tight monetary and fiscal policies, which only make matters worse.

Abandoning the Euro would be very costly, but it this crisis is revealing that the costs of membership are higher than many realized.