I very much agree with Avent and Smith that Cowen, who worries that such a policy would largely lead to inflation in Germany rather than a boom in Portugal, is completely missing the point; that’s a feature, not a bug.
But what really puzzles me about Cowen’s exposition here is his misplaced focus on the extent to which Portugal and Germany are in direct competition with each other, or to which Germany is Portugal’s main export market. This is very nearly irrelevant — because the point is that Germany and Portugal, for better or (mainly) worse, now share a currency, and what happens in Germany very much affects the value of that currency relative to other currencies.
Cowen writes that rising wages in Germany
solves (at best) only one of the core problems of the eurozone, namely incorrect relative prices between Portugal and Germany. It helps less with the “Portuguese nominal wages are too high” problem …
OK, stop right there. When you say “Portuguese nominal wages are too high”, you have to explain, too high relative to what? As Rudi Dornbusch always used to say, it takes two nominals to make a real.
And the answer, clearly, is “too high relative to German wages”. What else could it be?
But, you say, Portugal doesn’t compete that much with Germany. Ahem. Suppose that I could wave a magic wand (or play a few notes on a a Magic Flute) and suddenly increase all German wages by 20 percent. What do you think would happen to the value of the euro against the dollar and other currencies? It would drop a lot, yes? And Portuguese exports would become a lot more competitive everywhere, including non-German and indeed non-Euro destinations.
I guess I thought this was obvious. Apparently not.
Again, as Ryan says, the crucial difference between German/ Portuguese economic relations and, say, US/ El Salvador relations is that Germany and Portugal share a currency. This creates obligations for Germany, whether it likes them or not.