Krugman is a big believer in the idea “debt does not matter”. He made the mistake of using Italy as the prime example. Oops! Guess what? Debt matters. Now Krugman is attempting to pass off a foolish statement by blaming Original Sin for the Euro Crisis.
One question that keeps coming up is, how can I reconcile my scorn for warnings about bond vigilantes with what is happening to Italy? This seems especially pointed because I have in the past used Italy’s ability to carry debt exceeding its GDP as an illustration that debt concerns were overblown.
The answer lies in the concept of original sin. Not the Pope’s kind, but the economics kind — the long-standing notion that developing countries were especially vulnerable to financial crises because they borrowed in foreign currency.
The key point is that by joining the euro, Italy took a bite of the apple — it converted its advanced-country status, as a nation issuing debt in its own currency, into original sin, with debts in someone else’s currency (Europe’s in principle, Germany’s in practice). That is the root of its new vulnerability.
Krugman finishes with “More on all this later, I hope.” I hope so too, starting with my questions