Jun 13, 2011
Many believe that ditching the euro and bringing back the drachma would solve Greece’s problems. Others have the wrong impression that a Greek default automatically leads to an exit from the currency union.
However, Scotia Capital economists Derek Holt and Karen Cordes Woods think Greece should stay put and provide six reasons why a currency switch would do little to resolve the country’s woes.
- The positive impact of a currency devaluation would be offset by Greece’s inability to get the financing needed to drive a revival in exports.
- Inflation-adjusted wages must go down and productivity must remain flat or rise if currency devaluation is to work. However, real wages are stickier in Greece than they are in a fluid labour market like the United States.
- The impact of currency devaluation on prices is uncertain. However, the pass-through effects of currency changes into prices is thought to be weaker for the eurozone than for countries such as Canada.
- What exchange rate between the euro and a new drachma would Greece be allowed to leave with? Eurozone members may not be all that generous by allowing a fire-sale exchange rate for Greece. Rather, they may be more focused on guarding Europe’s own banking interests.
- Getting support from within the euro framework would position Greece better in the long run since reintroducing currencies like the drachma or lira would return some of Europe’s economies to their vices of the past. Currency depreciation and competitive devaluations were frequently used to absorb shocks, rather than a focus on structural and fiscal reforms required to improve productivity and drive growth.
- Defaulting and reintroducing the drachma could very well fuel contagion risk across the eurozone and have a negative feedback effect on Greece. “Given market tendencies, the bet would move on to who is next such that treating Greece as a separate, contained experiment is likely unrealistic,” the economists said.