A Case for Grexit

I think that the Greeks would be wise to abandon the Euro and introduce their own currency. Very few Greeks agree with me. Also many very smart economists around the world strongly strongly disagree with me. I will try to explain the case for a new Greek currency.

1) ECB blackmail is a crucial consideration. The ceiling on liquidity assistance (ELA) is binding. This is the reason Greek banks are closed. If Greece had its own currency, the Bank of Greece could lend as much of it as it pleased to Greek banks. The banks would be able to continue to handle electronic transfers (they are doing so at the moment but won’t be able to keep this up for long without more ELA or drachmas). As soon as Drachmas are printed, Greeks would be able to take them out of ATMs without limits (I guess some Greeks will take some out just to burn them in protest).

As soon as their banking system is independent of the ECB, Greece can threaten to default. The negotiations about debt repayment will be very different. I think this is a huge advantage for Greece.

In any case, without ECB blackmail, Greece will regain control over its own policy. Even if the Greek government can’t borrow, it can balance the budget by taxing last years profits and not by cutting already tiny pensions. The Eurogroup talks broke down on the question of tax increases vs spending cuts. The tax increases proposed by the Tsipras government are much less contractionary than the spending cuts demanded by the Troika. The debate between Greece vs the Troika is the debate between Keynes and Laffer. I think the evidence is clear that Syriza policy is based on sound economic considerations while the people who control the commission, the ECB and the IMF are clueless (notably not willing to listen to the IMF research department). The evidence for the second claim based on the effects of the policies they dictated (and their totally wrong predictions about these effects) is overwhelming.

2) with the drachma there will be inflation not deflation. This will be a very good thing. The long long US GDP decline from 29 though 33 ended exactly when prices ceased to fall and began to increase. When the US went off the gold standard it experienced record growth. FDR wasn’t the only person who took office in 1933, went off the gold standard, and watched GDP increase dramatically (Goodwin’s law trigger alert). I think that going off the Euro is a bit like going off gold and no policy has ever performed one tenth as well. With the inflation (which is likely to be high) the Bank of Greece can achieve negative real interest rates. Currently the lowest possible real rate is about 2%.

update: in the Washington Post Suzanne Daley reports that “Greeks Spend in Droves, Afraid of Losing Savings to a Bailout”. A spending spree is just what a country with deflation and 25% unemployment needs.

3) The Greek parliament can declare the Drachma legal tender. It can also decree that the word “Euro” in contracts is to be read as “drachma”. Workers will renegotation wages or strike, but creditors can only refuse to lend more (as they are already). Debt deflation is a choice for countries with their own currency. I think the transfer from creditors to debtors will stimulate demand.

4) money illusion is usually very powerful. In this case it will be much weakened by the fact that Greeks will continue to think in Euros. I don’t think it drachma nominal stickiness will be nonexistent (as it was in Germany in the fall but *not* the Spring of 1923). I expect Euro bearing tourists to get excellent bargains in Drachma using Greece. I think tourism should boom (note this argument is fourth and last).

So what is the case against Grexit which convinces almost all Greeks. After the jump I try my best

1) silly view one — economics is about the use of scarce resources — in this case EU subsidies which will be reduced. This is a standard way of thinking like an economist, which, only upon reflection, one realizes consists of thinking like a fresh water macroeconomist. It takes a lot of EU transfers to fill an Okun gap. If there is no good reason why Greece must have 25% unemployment, then even huge EU trasfers might be dwarfed by something else.

2) unemployment, at least in Continental Europe is an intractable problem with something to do with structural sclerosis so it won’t be easy for Grexited Greece to get unemployment down. Why look what happened when Thatcher pumped up the money supply in 1987 (the UK went from being the archetypal example of Eurosclerosis to an example of how English speaking countries differ from Europe) . Here the alternative to the silly idea is the hypothesis that European macro policy has been horrible for decades and that macro policy can affect output in what English speaking economists assume is the long run. There is basically no evidence that types of stimulus which work elsewhere fail to work in Europe.

3) Greece will have to be austere — deficits will be impossible if no one wants their bonds.
This requires the typical refusal to believe that the balanced budget multiplier is positive. If Greece can tax the rich (and it certainly can tax wealth) it can stimulate without borrowing. The Eurogroup talks broke down on the issue of tax increases vs pension cuts. The two plans would have yielded the same primary surplus if one takes GDP as given. The Greek approach was less contractionary and would have caused higher GDP. The Eurocrats turn out not only to be ideologues but to be Lafferite supply siders who think that the way to poison growth is to have the tax rates their countries had in the 3 or 4 decades after WWII (hint the period in which European GDP grew the most by far) .

But also and, I think more importantly, fiscal stimulus isn’t the only possible stimulus. Independent Greece will be able to manage stimulatory monetary policy because

4) the tragedy will be double digit inflation which is much more painful than 25% unemployment. I think this is just insane, but I know there are people who think this. Drachma prices will grow and grow. This will cause Greeks to hold low drachma real balances which will cause some shoe leather costs. These costs are universally estimated to be tiny compared to the cost of 1% more unemployment. But it wasn’t a Chicago loony who added inflation plus unemployment and called it a misery index (it was Okun forgetting that it takes a lot of Harberger triangles to fill an Okun gap). High inflation will make negative real interest rates possible. In other words, the Greeks who want something real not dubious depreciating drachmae will buy goods (also they will evade capital controls as much as they can).

5) OK but the rest of Europe will find some way to make Grexit horrible in order to make an example of Greece.

I think that 5 might be true and might be what the people are thinking.