Club Med and the Sun Belt: Lessons from adjustment within a monetary union
Uri Dadush, Zaahira Wyne, Shimelse Ali, 24 Jul 2012
The US and the Eurozone are slowly recovering after the bursting of their huge housing bubbles. Yet the hardest-hit states in the US have adjusted more rapidly than the most troubled European economies. This column examines differences between the US and Eurozone monetary unions that can help explain why.
The experiences of a few US states in weathering the ongoing economic turmoil could provide some insight into the Eurozone’s struggles. In particular, Florida, Arizona, and Nevada along the US Sun Belt saw a big housing bubble and subsequent bust, much like Greece, Ireland, and Spain along Europe’s periphery, a group we call ‘Club Med’. Both groups, each part of a monetary union, continue to suffer severely from the after effects of the crisis, but the Sun Belt states have recovered earlier and have not faced the trauma of a sovereign debt crisis. Some initial comparisons can be made about the experience of the two groups that could ultimately help shape the Eurozone’s long-term adjustments.
Market-driven adjustment to the crisis
The fact that the United States comes closer to being an optimal currency area than the Eurozone has been widely discussed among economists (see Table 1). But how did the differences between them affect the pace of adjustment in Club Med and the Sun Belt?
State-federal relations and the sovereign debt crisis
In Florida, Arizona, and Nevada, automatic fiscal stabilisers – lower tax liabilities to the federal government and increased receipts of transfers, including unemployment insurance, food stamps, Medicaid payments, and welfare – played a critical role in cushioning the shock.
The Eurozone: A work in progress
The severity and persistence of crisis in Greece, Ireland, and Spain as compared to Florida, Arizona, and Nevada following a similar asymmetric shock appears to owe relatively little to the inflexibility of the Club Med labour markets and more to the vulnerability of their government finances, the absence of countercyclical transfers, the link between sovereign risk and banking risk, and the slow pace of adjustment in their housing markets. Still, the realisation that the effect of the crisis on the Sun Belt continues to be so severe five years after their housing bubbles burst, despite the support given to them by the Federal government, is sobering, and begs the question as to how far the US is from an optimal currency area.