The Miracle of Currency Devaluation

Paul Krugman posts a chart highlighting the divergent fates of three small crisis-wracked countries, two with currencies pegged to the euro and one with a currency that floats:


Obviously the situation in Iceland is bad. But it’s much better than the situation in some other somewhat similarly situated countries, even though Iceland was ground-zero for the bust. You see around the world that developed countries that have done relatively well like Sweden and Israel have likewise seen the value of their currencies tumble.

In effect what’s happening in these places is a form of aggressive monetary policy. But while extremely aggressive monetary policy is politically controversial, the idea that countries with floating currencies might see the value of their currency go down is uncontroversial. Part of the reason, I think, is that the global elite is much more comfortable with things that look like “market outcomes” than things that look like “policy decisions” even though in reality the situations are symmetrical. A central bank’s decision to not act to halt devaluation counts as a policy decision, just as a central banks decision to not act to engage in hyper-aggressive monetary expansion is a real decision. When Milton Friedman argued that the Great Depression could primarily be understood as caused by bad Federal Reserve decision-making, some of the key decisions he had in mind were decisions to not act.

At any rate, you can argue theory until the cows come home. But the reality is that throughout this crisis the places that have “done more” have done better. Iceland is doing better than Estonia. The United States and the United Kingdom are doing better than the Eurozone. China is doing the most, and it’s doing the best.