Sunday, June 28, 2015

How might Greece leave the euro area?

Legacy 1000 Drachma Greek banknote
After the bundling of all IMF payments into one "jumbo" payment at the end of the month (June), together with the continued gulf between the Greek government and the "troika" (IMF, EU and ECB) in the negotiations for new measures to be agreed upon to release the bailout funds, the signs have now turned ominous for Greece.  The fact that the Greek government has announced that all banks will remain closed for the whole of this week from Monday (June 29th) and that capital controls are now in place, signifies that indeed Grexit is now a distinct possibility. 

Now Grexit clearly does not imply that a new currency must be formed, but to get any of the longer term benefits from Grexit (such as reclaiming an independent Greek monetary policy), the only way that this can occur is with a new Greek currency.  As an article in the FT today makes clear (see here), this is not a quick or easy process - but nevertheless it is certainly a possible outcome.

Now, as I have repeatedly argued here, Grexit is likely the best long term option for the majority of Greek people (see my paper from the University of Auckland Europe Institute here for the long version, and my previous posts from this blog, which are responses to FT letters for a the shorter version).  But the short term pain in getting back to an independent monetary policy again could be crippling and intense, if not managed properly. 

So what are the possible options for this to occur, given that Greece is probably not going to be in a position to make payments on it's debt, or to keep the euro as it's currency?

So, as I see it, Greece's options are:

i) try and hang on to the euro, despite the fact that Greece might not be in the euro area anymore;
ii) introduce a new currency, and (try and) adopt an orderly/managed exchange rate depreciation;
iii) introduce a new currency, and just let the new currency float on the open market; and
iv) use a new currency, but with a dual exchange rate - a commercial and a financial rate.

So let's deal with each of these options in turn, and try to sort out whether the transition over to any of these options would be more "orderly" or "disorderly", which is the language chosen by economists to signal panic or extremely rapid movements in financial variables (such as the stock market, currency values, or interest rates).

In theory, Greece could try to hang on to the euro as it's national currency, even though it would be no longer part of the euro area. But there has to be some escape valve from the crunch that the country finds itself in, which, if this were a country with a flexible exchange rate, would be depreciation, and if it had a fixed exchange rate, would be devaluation.  The problem here is that Greece is part of a monetary union and therefore only has the option of leaving the euro and massive lowering of the value of its currency.  So continuing to use the euro has none of the advantages of the other options.  Where it does have advantages is in terms of making sure that the debts of the country do not spiral any further out of control, as the majority of the debt is in euros.

The second option, that of the introduction of a new currency is a much more likely scenario.  Now, for arguments sake, let's call this new currency the "New Drachma".  The easiest way to engineer an "orderly" exit from the euro area is to then adopt (and announce in advance) a policy of temporary capital controls and then an initial exchange rate with a commitment to devalue the New Drachma against the euro on a regular basis ( - what economists call a "crawling peg").  This way, "hot" money flows cannot happen, but at the same time, Greece will see a fall in it's currency over time.  This will hopefully help the import sector to adjust to the new reality, and not cause a complete collapse in the import sector.  What would this peg be against?  

The third option, that of the introduction of a new currency that is allowed to float against the euro, with no capital controls, will no doubt lead to a disorderly exit from the euro.  This may well cause an initial over-reaction and see an overshoot from where the currency ideally needs to depreciate to, which may send the economy into further death spirals as importing businesses collapse. On the plus side though, this would lead to an immediate adjustment, from which the Greek economy (given the experience of the central and eastern European countries that tried this in the 1990s), would likely recover after one of maybe two years of drastic re-configuring of the Greek economy.  As a New York Times article recently discussed though (see here), this is likely to be extremely problematic from a debt perspective though, as most of the debt is denominated in euros, so a falling New Drachma would increase the debt load of both the public and private sector considerably.  This is one of the reasons why the Syriza government is anxious to avoid this option.  

The last option, that of some kind of dual exchange rate might be a good option given the struggle that the Greek government will still have to try to make interest payments on existing euro-denominated public debt. If the Greek government used a South African model for the exchange rate, then they would have a financial and a commercial New Drachma rate, where the financial rate would relate only to financial transactions, and all other transactions would occur at the commercial rate.  Note that this would still only require one currency. 

Out of these options, perhaps the best one is the fourth option, but there again, this is a difficult option to implement given that the market will want to see a quick fall in the value of the New Drachma, and yet because of capital controls on the financial side, this will not happen.  It will certainly not instill confidence among foreign investors however, as they will want to see the exchange rate fall to an extremely low level before even thinking of investing in the country.  Further, it will not help importers, and Greece imports a large amount of goods and services for use as intermediate inputs. 

Unfortunately, whatever route is chosen - either staying in the euro and accepting further austerity, or leaving the euro and trying to adjust to a new currency, it is going to be painful.

Sunday, June 21, 2015

Greece needs to leave the euro: Part IV

This is my response to a great article by Wolfgang Munchau in the FT on 21st June, 2015 which you can access here.

As usual, a great article from Wolfgang Munchau.

In one sense Munchau is over-reacting to the prospect of Grexit, and in another sense I think his reaction is perhaps understated.  So let me explain.

First, Munchau states that "The pretence of irreversibility is what distinguishes a monetary union from a fixed exchange rate system with a shared currency."  This is not accurate, as irreversibility was completely absent from the Latin Monetary Union of 1865, which Greece actually joined in 1867, and then was ejected from in 1908 (as were the Papal States at an earlier date). While the intent of a monetary union is not reversibility, there is nothing to stop some reverse actions occurring while maintaining the rest of the monetary union. Grexit need not threaten the rest of the euro area.

Second, economists have always claimed that the euro area requires a fiscal union if it is to become more sustainable and less susceptible to asymmetric shocks or the development of non-synchronous growth in a particular member state.  That is clearly stated in the optimal currency area theory which should be the economic foundation which forms the basis for any monetary union.

What Munchau does not state, but I think will be the result of this week's events is the realization among EU policymakers that they now have to deal with the reality of a "two (or even three) speed" EU.  There has always been the hope among European federalists that one day the EU will have the euro as it's currency, but this is now unlikely to be the reality unless further action (such as fiscal union) is taken.

To me, as an economist, the lesson is that although monetary union in the EU has been conceived in a political space and embodies the political ambitions of the EU elite, it will not succeed unless its economic foundations are solid.  As economists such as Willem Buiter stated years ago, there was both "sense and nonsense" in the Maastricht Treaty, and now we are about to pay the price for ignoring international economics in favor of establishing grand European political projects.

Saturday, June 20, 2015

Greece needs to leave the euro: Part III

The is my comment in the FT to an article by Larry Summers on Greece which you can read here published on June 20th, 2015.


Interesting article, but in my humble opinion pure hyperbole from Larry Summers.

Greece needs to leave the euro, and for reasons I have elucidated elsewhere ( - see my article here - - from the Europe Institute Journal of University of Auckland, NZ). But this needn't have the serious financial fallout that Summers refers to if handled properly, and for the following reasons:

i) We are not in the situation that we were in in 2010 - the other PIIGS member states are in much better shape, and although there will be concurrent rise in perceived default risk, the actual risks are all well contained, for the simple reason that the other economies are all now in expansion mode (or in the case of Italy, at least not in contraction mode). 

ii) This is not a situation that wasn't predicted by some pundits (including me), so plenty of preparations have been made for the fallout once Greece imposes capital controls, does an Argentianian freezing of all bank accounts, converts to a new (or legacy) currency and then sees a precipitous depreciation in the new currency.

iii) The Syriza government originally ran for election to government on getting out of the euro if austerity continued, so they will have fulfilled their mandate to the people of Greece, and although the pain will be sharp and incisive once the new currency depreciates, then the stage is set with a much more competitive economy, for economic growth.

Summers seems to wallow in some idealistic "coming together" of the two sides to avert crisis, but marriages do not necessarily always dissolve in crisis and likewise, this needs to be resolved in the best way possible for all parties concerned.  The Greeks need to leave the euro, the IMF needs to re-denominate the debt in SDRs and modify the conditions for repayment, and the Europeans need to take a haircut to give the Greeks the best chances of recovery, preferably with a payback trigger that is conditional on economic growth.

What Summers fails to mention as the downside is that the consequences for the impetus for European integration are much more serious.  The euro was meant to be a further step forward in the "ever-deepening" economic and political integration of the European Union.  It was never envisaged that a member of the single currency should leave, so Greece's departure portends a complete re-think on the role of the euro in the framework for European integration.  It points to the embedding of a two or even three speed Europe, which makes it much harder for political enthusiasts of integration to cook up (even in the longer term) further grand integration initiatives. 

I think that that European politicians and civil servants need to understand that just because something is labeled "European" doesn't mean that it is necessarily going to be the best option for all European Union member states. 

Tuesday, June 16, 2015

Greece needs to leave the euro: Part II

My response to a great article by Martin Wolf in the FT on 6/16/2015 which you can read here.


Excellent article by Martin Wolf, but not really too revealing on what the options might be. 

Governments are responsible to their voters, not to the holders of the country's national debt.  When you look at that chart of real domestic demand at around 68 percent of where it was in 2008, you also understand that the Greek government needs to stick to it's guns this time. 

The sad thing is that these negotiations have not allowed any latitude for new measures, such as perhaps the conversion of some of the existing debt to consols, or the future sale of some Greek assets (Mykonos?) - they have almost exclusively focused on extracting further austerity measures from the Greek negotiators.

Given the lack of any imaginative initiatives on the part of the negoatiators, the unsuitability of Greece for belonging to the euro area (due to it not satisfying the optimal currency area critieria), as well as it not properly fulfilling the Maastricht criteria for joining the euro in the first place, the Greek government now needs to plan it's exit from the euro.

Despite Mr. Wolf's concerns about Grexit, I really don't think these specific circumstances apply to any other euro area member states, so the prospect of any contagion is minimal..

The really sad thing is that this whole Grexit thng has been kicked so far down the road as far as it has. The can is looking pretty crushed and deformed now, having been kicked so much - so now is the time to take the can off the road and put it in the garbage, or recycle it! 

Tuesday, June 2, 2015

Greece needs to leave the euro: Part I

I wrote this comment in reply to a great article published by Martin Wolf in the FT today (6/3/2015) which you can find here 


Good article, but in my humble opinion some misconceptions.  

First, Martin Wolf makes the point that the euro area is not an OCA.  As my research has clearly shown (see my Bank of Finland discussion paper on this issue published 2 years ago, Greece does not have, and never did have, business cycles (or any other cycles for that matter) that are synchronous with the rest of the euro area.  It is simply not a good fit with the rest of the euro area, without (according to the OCA theory) there being sizable offsets which consist of fiscal transfers and much higher labor mobility.  And this is the case both ex-ante, and ex-post.  So, given this empirically proven stylized fact:

Second, the Greek government is simply wasting it's time and energy negotiating something that will not result in any long term membership of the euro - it will just be "another shot of medicine to help the dying patient".  I understand that the fact that the Greek government is actually negotiating is a necessary political pre-requisite to leaving the euro, but let's not drag this sorry Greek tragedy on any further than needs be, as this just prolongs and likely exacerbates the suffering of the Greek people.  

Third, Martin Wolf says that this will have a profound effect on the euro area and reverse the integration dynamic.  Well, hmmm, Greece is a little country the size of the State of Rhode Island in the context of the US - so it's not as if Spain or Italy were leaving. The euro area is 16 years old - and so its longevity won't depend on one small member deciding to leave early on it's evolution.  Also, the UK leaving the EU would have a much bigger impact on the integration dynamic than Greece leaving the euro area. 

Lastly, Wolf clearly wants Greece to stay inside the euro when he says that "This must be seen as a long game".  I mean how long do you want this game to be?  Governments simply don't think long term as their time horizons are short term or medium term at best. So the Syriza government really has the choice of alienating it's supporters and signing up to something that it promised never to sign up to, or pulling Greece out of the euro, which will create some chaos to begin with unless they have a proper plan B in place.  

If I were the Greek finance minister right now (which thankfully I am not), I would be furiously planning and comparing different strategies for a euro exit, as inevitably, that's what is the most likely outcome here.  

Now in part 2 of this blog, which will come out in the next couple of days, I will outline what I think the options are for Grexit.

Monday, June 1, 2015

One Answer to the Curious Case of Residual Seasonality in US Real GDP

Source: CNBC on my TV!
Recently, Steve Liesman from CNBC here in the US pointed out that something was wrong with the US real GDP statistics.  He noted, and here I attach a picture of my TV at home showing his findings, that since 1985, Q1 real GDP growth for the US has been weaker than for other quarters.  Of course this should not be the case given that statistical seasonal adjustments are supposed to take account of any seasonality in the data and automatically adjust for this.  So we clearly have a problem with the US real GDP data, but I believe that Bureau of Economic Analysis (BEA) who produce the data, are going to fix this going back a few years, for their revisions in July.

In a way, this is extremely problematic though, and it stems from the way in which the media in the US reports it's GDP figures.  In Europe and elsewhere in the world, the standard way to report economic growth is by calculating growth as % year over year change in real GDP, which automatically adjusts for any "residual seasonality" in the statistics.  But in the US, GDP figures are reported as "quarter on quarter growth expressed as an annualized rate" - which therefore does rely much more on an accurate adjustment for seasonality in the GDP figures.

Now you are probably thinking - "well who cares?"  Well unfortunately these figures are very important, not only in terms of setting the tone of the US stockmarket, but also in terms of policy measures, such as the adjustments of interest rates by the Fed!  Many of the market commentators saw the revised GDP figures last week with the "Second estimate" of Q1 GDP showing a contraction of 0.7% in (annualized growth in) real GDP as a blow to the recovery and tried to blame this on everything from the port strike on the West coast to the frigid weather in the first quarter. Even commentators said that the economy is too weak for the Fed to move in June to increase interest rates.

But I thought that for this week's blog I would take the real GDP growth figures and re-express them in terms of Year over Year growth. So that's exactly what I have done in the figure below.  This, I would argue is a much better way to judge our economic growth, and when you look at it this way, it is really not too shabby in my view.

Source:; Data calcs: Blog author
Now viewed in this light, a 0.7% contraction, turns into a 2.7% growth rate, which was an acceleration from Q4 of 2014.  Now if you look at the figure above, you'll see that although although consumer spending (C) is drifting in an upwards direction, it is 7.4% increase in private investment spending (I) that appears to have caused the uptick in the GDP % yoy growth data for Q1. Note also that since turning negative in 2010, government spending (G) has also moved into positive territory.

Now what of the international sector.  Well here, if you look at the data, the news isn't good whichever way you report it.  If you use the % YOY method that I use here, you will find that exports fell 22.7% YOY, and imports increased 6.5% YOY.  And in the investment category, if you take out the accumulation of inventories from the figures, investment only increased by 5.2%, which although still impressive, does suggest that business investment still needs to be boosted by consumer spending, which is still quite hesitant.

But from my own perspective, these figures bolster my view that although the Fed probably won't do a rate rise in June or July, they should.  The economy is growing as strongly as it has been at pretty much any time since 2010 when you measure economic growth in the best way possible, by using the %YOY method!  Also, while I know that the strength of the US dollar matters (more on that for another post), the main measure of robust growth in an economy is domestic spending or "absorption".  If the US Treasury and Fed have an exchange rate policy of benign neglect for the US dollar, then the movement of the US dollar should not dictate or effect the direction or timing of monetary policy.

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