Papadimitriou and Wray on the EZ as currency union

The grand experiment of a unified Europe with a common currency has entered its endgame. If the current trajectory continues, the disintegration of the euro is inevitable....

In sum, the collapse of the euro project will break in one of two ways. Looking increasingly likely, and least desirable, is that nations will leave the euro in a coordinated dissolution, which might ideally resemble an amicable divorce. As with most divorces,it would leave all the participants financially worse off. Wealthier countries would be back to the kinds of tariffs, transaction costs, and immobile labor and capital that inspired the euro in the first place. Poorer nations could kiss their subsidies, explicit and implicit, good-bye.

Less likely, but more desirable, would be a major economic restructuring leading toward increased European consolidation. Thus far, the real beneficiaries of the EU bailouts have been the banks that hold all the debt. But with some restructuring and alteration of regulations, that would not need to be the case. The doomed rescue plans we are seeing do not address the central problem: countries with very different economies are yoked to the same currency. Nations like Greece are not positioned to compete with countries that are more productive, like Germany, or that have lower production costs, like Latvia. Any workable plan to save the euro has to address those differences.

The best structural changes would even out trade imbalances by "refluxing" the surpluses of countries such as Germany, France, and the Netherlands into deficit countries by, for example, investing euros in them. Germany did this with the former East Germany following reunification. This kind of mechanism could be set up very quickly under the EFSF if it had a deeper well to draw from, probably one trillion euros.

Read or Download it at Levy Institute
Fiddling In Euroland As The Global
Meltdown Nears
by Dimitri B. Papadimitriou and L. Randall Wray
(h/t Michael Stephens at Multiplier Effect)