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Stefan Karlsson

Will Greek default really mean leaving the EU?

German leaders  have warned that if Greece cancels its austerity measures, Germany and others will stop funding the Greek budget deficit. That may not necessarily mean that Greece will be forced to exit the EU and reintroduce the drachma.

By Guest blogger / May 21, 2012

Supporters of the Greek Communist Party wave the party's flags during a rally in Athens in this May 2012 file photo. Far left political parties in Greece are losing ground amid warnings that a Greek default could mean being kicked out of the EU. But Karlsson argues that a default may not mean going back to the drachma.

John Kolesidis/Reuters/File

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Recent opinion polls suggests that many Greeks are listening to the warnings of German leaders that if Greece cancels its austerity measures, Germany and others will stop funding the Greek budget deficit, as the parties that want to keep Greece's commitments are gaining at the expense of the far left wing parties that wants to increase government spending.

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Stefan is an economist currently working in Sweden.

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But what if the far left end up winning after all and Greece defaults? Would that necessarily mean that Greece would be forced to re-introduce the drachma? Actually, contrary what is commonly assumed that is not necessarily the case. After all, households default around the world all the time yet except in cases of death or emigration they continue to use the same currency as before, so there is no necessay connection between default and exiting a currency. And as polls show that nearly 80% of Greeks want to keep the euro and so does the leading far left party, Syriza, even a far left governments that defaults will try to avoid exiting the euro.

However, if a far left government wants to increase, or simply avoid decreasing, government spending it will have to exit the euro and re-introduce the drachma. Because if Greece tells Germany that not only will it not honor the already dramatically reduced debt commitments, it wants to "borrow" (of course, if you keep "borrowing" while declaring previous debt null and void, you're really not getting loans, you're getting gifts) more so that it can spend more, then there is no way that Germany will agree to that-and rightly so. And since no private creditor will agree to it either, this means that Greece would be forced to immediately achieve primary budget balance, forcing it not only to cancel Syriza's promised spending increases but to cut spending in a disorderly fashion.

The only way this can be avoided, apart from implausible increases in government revenue, is if Greece re-introduces the drachma and starts to finance its budget deficit directly through the printing presses. So while default per se doesn't necessarily imply euro exit, deficit spending requires a euro exit. Meaning that Syriza's pledge to both increase government spending and keep the euro can't be achieved and that if they win they'll have to choose which of these promises they will break.

The Christian Science Monitor has assembled a diverse group of the best economy-related bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. This post originally ran on stefanmikarlsson.blogspot.com.

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