Should Greece ditch the euro?

Some think that Greece and other weak euro area countries would benefit from ditching the euro and introducing devalued national currencies. Are they right?

Petros Giannakouris/AP
Pedestrians pass a plaque portraying a Greek one-drachma coin, which was replaced by the euro in 2002, outside Athens City Hall, on Monday, May 14, 2012. Some argue that cash strapped European countries like Greece should get rid of the euro and go back to a devalued national currency.

Aside from Argentina, that I've discussed here, the most popular empirical example used to argue that Greece and other weak euro area countries would benefit from ditching the euro and introduce devalued national currencies, is the experience of the 1930.
Though there are differences between the euro and the gold standard, they are similar in the sense that both means fixed exchange rates and the inability to devalue/depreciate the currency.

And the empirical record of the 1930s is pretty clear. The faster countries got off the gold standard the faster they recovered. Britain and Sweden that devalued first recovered first, the United States devalued somewhat later and recovered somewhat later, while France and Belgium that held on to the gold standard the longest recovered latest of all countries.

This strong correlation was in fact mostly causal. The reason was that bank panics had caused wide scale collapses of fractional reserve banks creating in turn what Hayek called secondary deflation in very high doses, often as high as 10% per year, something that given the inability of nominal interest rates to go below zero meant that real interest rates was as high as 10%-far above the natural interest rate, causing not only malinvestments but also fundamentally sound investments to be liquidated. And when other countries devalued this helped aggravate this secondary deflation.

When those unnaturally high real interest rates were dramatically lowered after the gold standard was abandoned, this caused the economies to recover.
However, in the euro area today we see no secondary deflation. Price inflation is well above 2.5% in the euro area, and even in Greece it is still 1.5%. That is why we can't expect a similar development if Greece or others re-introduce their currencies. Eventually at some point during the coming years they will almost certainly see some form of recovery, but that will happen regardless whether they stay in the euro are or not.

The baltic countries have seen their economies recover strongly ( Estonia's GDP have increased a cumulative 13.9%, Latvia's by 10.5% during the last two years), albeit from a very depressed level, despite not devaluing while Britain and Iceland failed to see any recovery following the dramatic drop in the value of their currencies in 2008, illustrating that devaluations only work if it is made in the context of secondary deflation.

You've read  of  free articles. Subscribe to continue.

Dear Reader,

About a year ago, I happened upon this statement about the Monitor in the Harvard Business Review – under the charming heading of “do things that don’t interest you”:

“Many things that end up” being meaningful, writes social scientist Joseph Grenny, “have come from conference workshops, articles, or online videos that began as a chore and ended with an insight. My work in Kenya, for example, was heavily influenced by a Christian Science Monitor article I had forced myself to read 10 years earlier. Sometimes, we call things ‘boring’ simply because they lie outside the box we are currently in.”

If you were to come up with a punchline to a joke about the Monitor, that would probably be it. We’re seen as being global, fair, insightful, and perhaps a bit too earnest. We’re the bran muffin of journalism.

But you know what? We change lives. And I’m going to argue that we change lives precisely because we force open that too-small box that most human beings think they live in.

The Monitor is a peculiar little publication that’s hard for the world to figure out. We’re run by a church, but we’re not only for church members and we’re not about converting people. We’re known as being fair even as the world becomes as polarized as at any time since the newspaper’s founding in 1908.

We have a mission beyond circulation, we want to bridge divides. We’re about kicking down the door of thought everywhere and saying, “You are bigger and more capable than you realize. And we can prove it.”

If you’re looking for bran muffin journalism, you can subscribe to the Monitor for $15. You’ll get the Monitor Weekly magazine, the Monitor Daily email, and unlimited access to CSMonitor.com.