Monetary policy is confusing, but one thing most people understand is currency devaluation: Make your currency cheaper and foreigners will buy lots of stuff from you generating jobs and growth. The two are largely synonymous but not a lot of people understand that.
One person who I thought would understood that is renowned macroeconomist and economic geographer Paul Krugman. So even though I’m on his turf, and this post brings me directly into conflict with rule one, I’m going to plough on regardless. Today he expresses some disbelief towards the idea that a devaluation of the Euro would be feasible:
Jeremy Siegel echoes a lot of what some of us have been saying for years about the infeasibility of internal devaluation, but then argues that the answer is devaluation of the euro as a whole. Um, against whom?
He goes on to argue that neither Japan, America nor the developing world can provide the stimulus Europe needs as each suffers from various degrees of a depressionary malaise. But elsewhere he has called for more monetary stimulus to help resolve the Eurozone crisis:
I’d still like to imagine that next week Mario Draghi, newly installed as ECB president, will suddenly reveal himself as a supporter of quantitative easing and a 4 percent inflation target, not to mention open-ended lending to crisis countries.
Think of it this way: Krugman may be correct that Japan, US, UK etc. could not tolerate a cheaper euro, but this is logically seperate from saying the ECB shouldn’t try and devalue. This is because there are steps other Central Banks could take to prevent a cheaper Euro from negatively impacting them. Imagine the ECB buys lots of American, Japanese and British bonds in an attempt to devalue the Euro to boost growth. In that case, the Fed, BoJ and BoE could do the opposite and buy the bonds of Eurozone countries.
Sound familiar? It should. Because you would have just instigated an international quantitative easing programme, with each country buying debt from another; more QE is just what Krugman suggests is needed of Mario Draghi in the above quote. It is an odd way to organise it, but the mechanism behind it would be very similar. The currencies wouldn’t exactly devalue against one another, but they would devalue against everything else.
The ECB is a monetary superpower, much like the Fed. If it tried to devalue by encouraging a devaluation other countries would have to react with more expansionary policies of their own. When the Fed was too inflationary through the 1970s it exported it around the world, much as its tight policy was exported in 2008. All the main thing an attempted ECB devaluation would acheive would be to export more expansionary policy around the world, something sorely needed.
Still not convinced? Lets look at some history. Below is a graph I cribbed from Brad DeLong which shows the dates at which countries left the Gold Standard and the dates at which they began their recoveries.
The abandonment of the Gold Standard allowed for a country to revalue its currency. One of the thing which prompted countries to abandon the Gold Standard was that other countries had done so first, expansionary policy was exported just as contractionary policy was exported prior to 1930. In a sense every country tried to devalue against all the others (the sequence of events and mentality of the Gold Standard is discussed here further).
Since every country cannot actually devalue against all the others what instead happened is that each national currency devalued against most other goods, in other words each country’s price level and real production began to converge (and eventually surpass) pre-depression levels. The same would probably occur were the ECB to seriously try to devalue the Euro today.
Bringing us back to the start, Krugman thinks that the EU, UK, US, Japan, and much of the rest of the world need more demand and yet pooh poohed a policy which would deliver it both directly within the Eurozone and indirectly through prompting policy changes abroad. To be honest, Krugman’s incredulity leaves me a little confused. Even if exchange rates changed not one iota, so long as each country maintains the policy described above demand would increase across the world, which is exactly what he wants.
UPDATE: Huh?! I’m having trouble parsing this. Brad DeLong links approvingly to the Krugman piece above saying that there’s no point trying to devalue, countries just need more expansionary policy, contra my point that devaluation is expansionary policy. But he also approvingly links to a paper on countries abandoning the Gold Standard (by Eichengreen again, as above) that says a more aggressive policy of competitive devaluation during the Great Depression would have been even more beneficial for the system as a whole compared with actual policy, because it would have been more expansionary in the way I described. 
A Euro devaluation which was met by totally passivity by the Fed, BoE and BoJ may have negative effects on net (although given the fragility of the Eurozone anything which helps stabilise it might be expansionary by whit of improving financial stability). Neither Brad nor Paul think the world’s central banks would be passive if faced with a policy of competitive devaluation from the ECB so the two arguments presented by Brad are mutually exclusive, not complementary, yet he uses one to support the other…
 Although I’d not read that 1986 paper before, I appear to have absorbed its lessons by osmosis, probably through reading Brad DeLong’s excellent blog come to think of it.
UPDATE the SECOND: Matthew Yglesias has written the exact same post as me, different words, but almost an identical structure. but with one difference, he’s gone soft on Krugman’s assumption of central bank passivity, which we know he thinks is a poor assumption in other situations.