Tags: Feldstein | euro | currency | Devaluation

Harvard’s Feldstein: Devaluation May Save the Euro, Contain Crisis

By    |   Thursday, 28 June 2012 09:47 AM

The only way to save the eurozone may be for policy makers to engineer a sharp decline in the value of the euro currency versus the dollar and other currencies, argues Martin Feldstein, a Harvard University economics professor and former chief economic adviser to President Ronald Reagan.

A devaluation of the euro of about 20 percent would increase exports of the region, particularly of the endangered peripheral countries like Greece and Spain, allowing them to reduce their trade deficits and spur growth, he writes in a Wall Street Journal op ed.

European politicians’ calls for a political union and permanent fiscal transfers won’t solve the many problems facing the peripheral countries – especially on the need to move quickly to halt the collapse of the currency, he writes.

For Greece, Spain, Portugal, and other peripheral countries to remain in the eurozone they must solve four problems, he says. First, they must permanently lower their fiscal deficits to reduce the interest rates on their sovereign bonds to sustainable levels.

They must spur job creation to generate support for the fiscal consolidations, he says. Commercial banks must be recapitalized to preserve lending capacity. Fourthly, trade deficits must be eliminated so those countries are not permanently seeking transfers or loans from foreign creditors, he writes.

Politically difficult decisions could solve the first three issues, but they would not resolve the trade and current account deficits, which reflect the peripheral countries’ lower competitiveness versus Germany and the northern tier of euro countries.

If the peripheral countries left the eurozone, they would be free to devalue their currencies to spur exports and growth and undertake fiscal consolidation programs, remedies adopted by countries in Latin America, East Asia and, most recently, the U.K., he writes. A devaluation of the single currency could achieve some of the same goals while holding the eurozone together, says Feldstein.

Euro-area finance ministers gathered in Brussels Thursday to approve a bailout plan for Cyprus and discuss an aid plan for Spanish banks. German Chancellor Angela Merkel is likely to reiterate her rejection of euro-area bonds to lower borrowing costs for Spain and other peripheral countries, Bloomberg News reported.

French President Francois Hollande, Italian Prime Minister Mario Monti and Spanish Premier Mariano Rajoy have been pushing for quicker action, including structural reforms, to ease the crisis that began in Greece in late 2009.

“The key negotiators, including the German chancellor, do not really understand the timeframe we’re working under,” Niall Ferguson, a professor of economic history at Harvard University, told a conference Wednesday in London.

“The timeframe for financial crises is days. The timeframe for structural reforms is years,” he said, according to Bloomberg.

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