Panicos Demetriades, University of Leicester
A recent piece in the FT by Samuel Brittan on the eurozone’s current troubles (“Who is winning in the race for recovery”, May 13) suggests that the currency area urgently needs a Plan B, involving an orderly withdrawal of Greece and Portugal. A similar argument has been made by Simon Tilford, who argues that Greece and Portugal should both go gracefully”.
While I agree with most of the economic analysis in both pieces, I do not think that the departure of Greece and Portugal is the only or the best solution to the eurozone’s current troubles. Indeed, I would argue that the rebirth of the DM makes a lot more economic sense.
There is no doubt that both Greece and Portugal desperately need a devaluation of their currency to return to positive growth territory. But so does the rest of the periphery, including Ireland and Spain. The main reason the eurozone is not an optimal currency area is not so much the weakness of the Greek and Portuguese economies but the strength of the German one.
If the DM could be reintroduced, the euro would quickly decline to a level that would help re-instate the competitiveness of the periphery. The fiscal improvement will lessen the need for further draconian austerity measures which, in all likelihood, will make matters worse. With positive growth, confidence will return and interest rates on the debt of the periphery will decline. This could make debt ratios of over 100% sustainable. There are plenty of examples from history (e.g. the US after the end of WWII) where such high debt ratios gradually declined to more manageable levels. Positive growth rates were the key.
Moreover, there are benefits for Germany. The DM would quickly become a sensible alternative to the dollar as a reserve currency, as the Bundesbank regains its status as the toughest central bank on inflation in the world. No doubt, as it appreciates German products would initially become less competitive, but with the rest of Europe growing strongly, they will quickly become more affordable.
More importantly at this juncture, the rebirth of the DM has the potential to prevent a costly restructuring of the debt of the periphery saving banks – and ultimately taxpayers – in Germany, France and other countries hundreds of billions of Euros. Plan B, on the other hand, will not prevent such losses, as the debt burden of Greece and Portugal will become even more unsustainable when the new drachma and escudo are introduced.
Moreover, without German resistance, the prospect of a fiscal union – which is what is needed to make a currency union work – will get closer. With automatic fiscal transfers and stabilisers, negative real shocks will be dampened and the currency union will become sustainable. Finally, with a fiscal union in place, the flawed Stability and Growth Pact, which is not only a poor relative of a fiscal union but ultimately the source of a lot of the instability we are witnessing, will be retired.
As to Plan A, it is abundantly clear that it is not working. The brave attempts of the eurocrats to convince the markets otherwise, if anything, erode confidence in the euro as analysts and economists begin to interpret their unwillingness to face the facts as incompetence.
The only remaining question to settle is what will happen to countries like Austria, Finland and the Netherlands. Would they stomach the greater subsidies to the periphery that a fiscal union entails and remain in the euro zone? Or would they prefer to adopt the DM and join Germany in another currency union?
All this is of course secondary to finding a politically face saving way towards something that makes perfect economic sense.
It is time for Plan C.
Panicos Demetriades is Professor of Financial Economics at the University of Leicester. He holds a PhD in Economics from the University of Cambridge. His research interests are in the area of finance and development. His work has frequently challenged mainstream views. For example, as early as 1996 he warned against accepting the view that more finance is always good for growth.
Panicos is Treasurer of the Money, Macro and Finance Research Group:
His publications include:
- “Government Ownership of Banks, Institutions and Economic Growth” (with S. Andrianova and A. Shortland), Economica (forthcoming).
- “Political Economy Origins of Financial Markets in Europe and Asia” (with S. Andianova and C. Xu), World Development (Forthcoming). (available online at Science Direct).
- “Information, Institutions and Banking Sector Development in West Africa” (with D. Fielding), Economic Inquiry, forthcoming. (available online at Economic Inquiry).
- (2010)”Creditor Protection and Banking System Development in India” (with S. Deakin and G. James), Economics Letters, vol. 108, 19-21, (available online at Science Direct).
- (2009) ‘Financial Development and Openness: Evidence from Panel Data’ (with B. Baltagi and S.H. Law), Journal of Development Economics, vol. 89, 285-296, (available online at Science Direct).
- (2008) ‘Government Ownership of Banks, Institutions and Financial Development’ (with Svetlana Andrianova and Anja Shortland), Journal of Development Economics, vol. 85, 218-252, (available online at Science Direct).
- (2005) ‘Monetary Policy and the Exchange Rate during the Asian Crisis: Identification through Heteroskedasticity’ (with A. Cipollini and G. Caporale), Journal of International Money and Finance, vol. 24, 39-53, (available online at Science Direct)
- (2003) ‘International Aspects of Public Infrastructure Investment’ (with S. Bougheas and E. Morgenroth), Canadian Journal of Economics, Vol. 36, No. 4, November 2003, 884-910
- (2001) ‘Financial Development and Economic Growth: The Role of Stock Markets’ Journal of Money, Credit and Banking, 33, 16-41 (with P. Arestis and K. Luintel)
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