Macroeconomic imbalances and the Euro crisis High inflation of wages and prices in Europe’s south (including Ireland) and the misallocation of capital due to low interest rates are thought to have caused losses of competitiveness, which have slowed down growth and rendered budget deficits unsustainable (Sinn, 2013). A correlate of this argument is the view that excessive current account deficits have created unsustainable “external” debt positions, which need to be brought down. Because the exchange rate is no longer available as an adjustment tool, the only policy action available is a cure of austerity, which must restore equilibrium in those countries. However, there are lots of inconsistencies between this story and the observed facts. Wyplosz (2013) has rightly reminded us that correlations, simultaneity and causality are not the same thing. One should therefore be careful in interpreting the evidence. Even the theory of monetary union deserves reconsideration. While optimum currency area theory has focussed on labour mobility as the necessary (and sufficient) condition for a workable monetary union, Collignon (2013) has argued that even large current account deficits within the same currency area are robustly sustainable, and possibly even a sign of efficient resource allocation in a deeply integrated single market, because a monetary union is a payment union and not a fixed exchange rate regime. The difference is that in a monetary union all payments are made in domestic currency, which is obtained by banks from the central bank. Any bank in the currency has access to this liquidity at equal conditions. While it is true that in the long run that the central bank restricts money supply in view of maintaining price stability, in the very short run it must insure that solvent banks do not run out of liquidity. By contrast, between different currency areas, payments are made in foreign currency, which is obtained by current account surpluses or capital flow. When current accounts are negative and the capital inflow suddenly stops, the central bank runs out of foreign reserves (i.e. it becomes illiquid) and the exchange rate depreciates. Yet, the experience of the 1970-90s has clearly shown that, at least in Europe, the exchange rate is not a policy tool that can be used to deliberately manage competitiveness. The reason why a monetary union is more robust than a fixed exchange rate regime derives from the fact that domestic credit is an additional source of finance which is not available in foreign exchange (...)

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