To the Editor:

According to Niall Ferguson and Laurence J. Kotlikoff, some EMU members will opt to leave the eurozone to pursue a more inflationary policy -- thereby reducing the value of their debts, even as their currency becomes worthless. This argument is faulty for three reasons.

First, despite the fact that secession from EMU is simply not allowed by the Maastricht Treaty, the political cost would be so large (including the possible breakup of the European Union itself) that a bailout (also forbidden by the treaty but much less costly) would be preferable to any serious separation plan.

Second, Ferguson and Kotlikoff underestimate European governments, as well as their capacity to address their unsustainable fiscal stance more reasonably. Here, recent history is a good guide. Whoever thought that Italy would join EMU in 1999 and Greece in 2001? Even though Italy cheated at the margins (as did Germany), the fiscal adjustment has been astonishing by the standards of Italian politics.

Third, in modern economies with efficient tax collection and open financial markets, inflation does not really emerge as a natural "last resort" solution to fiscal insolvency. Higher taxes and lower spending could well work better. Strangely, the authors forget to mention that inflation is just another tax: a tax on nonindexed assets. On average, European households are big net savers and prefer to invest in public bonds. A one-shot tax on wealth (proposed in the mid-1990s to cut Belgium's public debt) would likely be preferred to the inflation tax. Splitting emu to allow member states to default on their obligation through inflation is silly if one agrees that there exist other, politically less costly ways to restore government solvency.


Postdoctoral Fellow, Department of Economics, Harvard University