Friday, May 7, 2010

Krugman on Exiting the Euro


“The only thing that could seriously reduce Greek pain would be an economic recovery, which would both generate higher revenues, reducing the need for spending cuts, and create jobs. If Greece had its own currency, it could try to engineer such a recovery by devaluing that currency, increasing its export competitiveness. But Greece is on the euro. So how does this end?

Logically, I see three ways Greece could stay on the euro.

First, Greek workers could redeem themselves through suffering, accepting large wage cuts that make Greece competitive enough to add jobs again. Second, the European Central Bank could engage in much more expansionary policy, among other things buying lots of government debt, and accepting — indeed welcoming — the resulting inflation; this would make adjustment in Greece and other troubled euro-zone nations much easier. Or third, Berlin could become to Athens what Washington is to Sacramento — that is, fiscally stronger European governments could offer their weaker neighbors enough aid to make the crisis bearable.

The trouble, of course, is that none of these alternatives seem politically plausible.

What remains seems unthinkable: Greece leaving the euro. But when you’ve ruled out everything else, that’s what’s left.”

My comment: I agree of course (see my previous post). Krugman mentions the similar experience of Argentina. Two remarks: first the predicament of Argentina seemed at the time at least as serious as the present Greek one does. But nevertheless the economy recovered quickly after the default and the exit from the peg to the US dollar. Second, the FMI did the same mistake that it is now repeating with Greece, believing that lending more money and restructuring the debt would do. It didn’t.

For Greece, the alternative policy of default and exiting the euro now seems definitely less damaging than pursuing a policy of drastic deflation for many years without real hope of recovery (and with aggravated deficits), which leads to chaotic social unrest. That’s why Eichengreen is basically wrong when he pretends that entering a currency zone such as the eurozone is an irreversible move, as I noted in an earlier post.

Read the whole Krugman paper, A Money Too Far .

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