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Wednesday, February 17, 2010

"Let Greece take a Eurozone Holiday"

Martin Feldstein says allowing Greece to temporarily move into its own currency and reset its exchange rate would help it to overcome its economic difficulties:

Let Greece take a eurozone ‘holiday’, by Martin Feldstein, Commentary, Financial Times: Loan guarantees or temporary credits from Germany and France may allow Greece to avoid a refunding crisis later this spring. But temporary financial patches will not deal with the real problem: Greece’s budget deficit of 13 per cent of gross domestic product. .......Greece needs to cut future annual spending and increase its future taxes in a com­bination equivalent to at least 10 per cent of GDP.
Unfortunately, such a fiscal contraction would sharply increase unemployment, already at a painful 10 per cent... If Greece still had its own currency, it could, in parallel, devalue the drachma to reduce imports and raise exports... But since Greece no longer has its own currency, it is not free to follow this strategy.
So what can Greece do? ...The rest of the eurozone could allow Greece to take a temporary leave of absence... More specifically, Greece would shift its currency from the euro to the drachma, with an initial exchange rate of one euro to one drachma. Bank balances and obligations would remain in euros. Wages and prices would be set in drachma.
If the agreement called for Greece to return at an exchange rate of 1.3 drachmas per euro, the Greek currency would immediately fall by about 30 per cent relative to the euro and other non-euro currencies. ...Greek products would be substantially more competitive in both domestic and foreign markets.
In exchange for permission to reset its exchange rate, Greece would have to agree to tough fiscal measures to bring its budget deficit down quickly and keep it down. ...
Other eurozone members might object to giving Greece this improved competitiveness. They might worry that other countries with large trade deficits would press for a similar deal. But allowing Greece to reset its exchange rate might still be better than having the country permanently leave the eurozone. It would certainly be better than condemning the Greek people to a decade of suffering. It would also be better than Germany and other countries providing continual financial assistance to Greece, since such a process might make Germany itself want to quit the eurozone. ...
If European political leaders ... want to preserve the current system, allowing a temporary exchange rate reset for Greece may be the best option.

    Posted by on Wednesday, February 17, 2010 at 01:54 AM in Budget Deficit, Economics, International Finance | Permalink  Comments (23)


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