Sebastian Mallaby and Paul Krugman explain that the PIIGS have monetary as well as fiscal problems. That is, their wages are too high, and there is not enough labor mobility to produce the needed adjustment (hence, as many economists argued, Europe is not an optimal currency area). Mallaby writes,

But a eurozone member that allows wages to rise unsustainably has no such easy exit. It cannot regain its competitiveness by the usual trick of devaluing its currency because it no longer has its own currency…

what happens when an indebted country tries to become competitive by forcing wages down? Falling wages means deflation, and deflation increases the burden of those debts — if you owe a bundle on your credit card and your wages take a sudden hit, you will struggle to make your next payment. Because of this debt-deflation pincer, uncompetitive and indebted countries must choose between default and leaving the euro.

Krugman writes,

The deficit hawks are already trying to appropriate the European crisis, presenting it as an object lesson in the evils of government red ink. What the crisis really demonstrates, however, is the dangers of putting yourself in a policy straitjacket. When they joined the euro, the governments of Greece, Portugal and Spain denied themselves the ability to do some bad things, like printing too much money; but they also denied themselves the ability to respond flexibly to events.

I want to push back against both Mallaby and Krugman. Suppose Greece had not been on the euro, and Greece had run the same sorts of budget deficits. Assuming that Greece had borrowed in drachmas, yes, they could have devalued the drachma, which would have both cushioned the drop in demand from fiscal tightening (I’m playing by Keynesian rules in this post) and deflated away some of their debt. On the other hand, if Greece had borrowed in euros (or francs or marks), then they would face the very debt-deflation pincer to which Mallaby refers. In that case, devaluation would raise the cost of their debt.

One cannot just brush aside the fiscal profligacy issues.

Moreover, there is one policy that would address both the fiscal problem and the monetary problem: cut public sector wages by, say, ten percent until the crisis blows over. This clearly helps the fiscal problem. In addition, it makes it easier for the private sector to cut wages, which eases the monetary problem.

And yes, Nick Rowe and Scott Sumner, it probably would help if the european monetary authority would print more euros.