Krugman: His Lucid Best on Euro Crisis and Its Implications

Legends of the Fail - NYTimes.com

Borrowing, if you must, in your own sovereign currency matters, and austerity never works, especially during a recession. Here are the facts, though I coud add the caveat if I were a neoclassical economist that those high interest rates for Spain and Italy are also, no matter what the currency, the result of lack of investor confidence in the economies of those countries. But I'm not, so I'll just say had the countries been able to manipulate fiscal and monetary policy with their own currencies instead of being locked into the Euro, which is controlled by the more wealthy EU countries - namely, Germany and France - there would be no investor confidence issue.

"... if you look around the world you see that the big determining factor for interest rates isn’t the level of government debt but whether a government borrows in its own currency. Japan is much more deeply in debt than Italy, but the interest rate on long-term Japanese bonds is only about 1 percent to Italy’s 7 percent. Britain’s fiscal prospects look worse than Spain’s, but Britain can borrow at just a bit over 2 percent, while Spain is paying almost 6 percent.

What has happened, it turns out, is that by going on the euro, Spain and Italy in effect reduced themselves to the status of third-world countries that have to borrow in someone else’s currency, with all the loss of flexibility that implies. In particular, since euro-area countries can’t print money even in an emergency, they’re subject to funding disruptions in a way that nations that kept their own currencies aren’t — and the result is what you see right now. America, which borrows in dollars, doesn’t have that problem.

The other thing you need to know is that in the face of the current crisis, austerity has been a failure everywhere it has been tried: no country with significant debts has managed to slash its way back into the good graces of the financial markets. For example, Ireland is the good boy of Europe, having responded to its debt problems with savage austerity that has driven its unemployment rate to 14 percent. Yet the interest rate on Irish bonds is still above 8 percent — worse than Italy."

See too my earlier posts:
Pathological Commitment to the Ideology of Austerity Brings Only Economic Stagnation
Fiscal Austerity: Does it Work?