Among the many worries Ben Bernanke listed in his speech at the New York Economic Club today is the continued danger of a meltdown in Europe:
The elevated levels of stress in European economies and uncertainty about how the problems there will be resolved are adding to the risks that U.S. financial institutions, businesses, and households must consider when making lending and investment decisions…. Weaker economic conditions in Europe and other parts of the world have also weighed on U.S. exports and corporate earnings.
And rather than being a single crisis that will pass, the European Monetary Union faces a chronic structural problem: a single currency means having a single monetary policy for all of the disparate countries in the euro zone. So some economists have called for the reintroduction of the German mark. (See for example, Kenneth Griffin and Anil Kashyap’s New York Times op-ed “To Save the Euro, Leave It.”and my own evolution toward that view in “The Euro and the Mark.”)
Beyond whatever hit to confidence the rest of the euro zone would suffer, the problem with reintroducing the deutsche mark is that the inevitable rise in the value of a free-floating mark relative to value of the euro would hurt German exports, as well as increasing imports into Germany, and throw Germany into a recession. The Bundesbank, once again the central bank of Germany, would have difficulty implementing expansionary monetary policy, since interest rates in Germany are already close to zero.
Fortunately, the solution to this problem is ready at hand, since the reintroduction of the mark would be a golden opportunity to implement another dramatic, forward-leaning change to the monetary system in Germany—and perhaps in the rest of the euro zone. In short, for a smooth transition, a reintroduced mark needs to be an electronic mark. I recently made the case for the electronic dollar in a previous Quartz column, “E-Money: How paper currency is holding the US recovery back.” The trouble with paper money is that the rate of interest people earn on holding paper money puts a floor on the interest rate they are willing to accept in doing any other lending. For the US, I proposed making the electronic dollar the “unit of account” or economic yardstick for prices and other economic values, and having the Federal Reserve control the exchange rate between electronic dollars and paper dollars to make paper dollars gradually fall in value relative to electronic dollars during periods of time when the Fed wants room to make the interest rate negative.
In the case of Germany, there would be no need to reintroduce a paper mark along with the electronic mark, since the euro itself could continue in its current role as a “medium of exchange” for making purchases in Germany, alongside the electronic mark. A “crawling peg” exchange rate could be used to let the electronic mark gradually go up in value relative to the euro, without causing a huge rush into the mark, since with no paper mark other than the euro itself, interest rates in Germany could be close to zero when measured in euros, which would make them strongly negative in terms of marks.
Looking at what would happen from the perspective of the rest of the euro zone makes clear how the economics would work. While prices in Germany would be steady in terms of the electronic mark, they would be gradually increasing, according to plan, when measured in euros. The electronic mark would also tend to rise relative to other currencies, while the euro would tend to fall relative to other currencies. These exchange rate changes would do two things. First, goods in the rest of Europe gradually become more competitive as the German goods they are competing with rise in their euro-equivalent price, and as the euro fell relative to other currencies. Second, knowledge that German goods were rising in price would encourage buyers within the rest of the euro zone and around the world to buy German machine tools and other durable exports now instead of later when those goods would be more expensive. This desire by foreign buyers to accelerate their purchase of German machine tools and other durables due to the upward trend in the electronic mark’s value would provide a powerful stimulus to the German economy that would counteract the short-run negative demand effects from the higher level of the electronic mark’s value. But this buy-it-now effect would fall prey to higher interest rates if a reintroduced paper mark were there, pushing up interest rates.
Overall, there would be a powerful stimulus to both the German economy and the economies in the rest of the euro zone, as long as increase in the electronic mark’s value was fast enough. This is not so surprising when remembering that, from Germany’s point of view, German interest rates would be strongly negative, able to provide as much stimulus as needed. (Indeed, care would be required to avoid too much stimulus.)
Historically, fixed exchange rates, of which such a “crawling peg” is an example, have often been hard to defend. But there is an answer to that objection that is also a partial solution to the political and symbolic problem of having Germany leave the euro zone that Rudi Bachmann and I discussed in our Quartz column,“Symbol Wanted: Maybe Europe’s unity doesn’t rest on its currency. Joint mission to Mars anyone?” If Germany remained within the orbit of the European Central Bank, or ECB, then the Bundesbank, as the agent of the ECB, would always be able to mint enough euros or electronic marks to defend the crawling peg exchange rate between euros and electronic marks. The details of the crawling peg could be determined, collectively, by the members of the euro zone, with a strong voice for Germany in a decision that would affect it so much. By introducing the electronic mark, but remaining within the orbit of the ECB, Germany would demonstrate that a more flexible monetary and exchange rate policy is consistent with a unified Europe. What Europe needs is more degrees of freedom for monetary policy, not a return to the European rivalries that brought us two world wars.