NCPA - National Center for Policy Analysis

Beginning of the End for the Euro?

June 13, 2012

Rising debt in southern European countries threatens the euro's dissolution just 13 years after it was introduced.  Opinion is now divided about whether the euro can survive Greece's exit, or "Grexit," as some have dubbed it.  The outcome hinges on upcoming elections in Greece, says Jagadeesh Gokhale, a senior fellow at the Cato Institute.

There may be some hope if Greek voters decisively restore power to pro-bailout parties, but none if they strengthen extremist anti-bailout parties, or if the election result remains inconclusive.  Under the latter two scenarios, Greece will run out of time and money too quickly to prevent institutional chaos in the short term.  This leaves the Greek people with three distinct policy paths:

  • Remain a member of the euro zone and accept the severe austerity measures that have been offered, allowing for the near-certain economic contraction that would follow.
  • Petition Germany for a more relaxed austerity schedule that would ideally allow Greece to recover budgetary solvency while avoiding a severe economic contraction.
  • Leave the euro zone and return to the drachma, thereby regaining economic competitiveness over time but only after undergoing a large devaluation, inflation and significant austerity for current generations.

The first and last options bring with them significant economic uncertainty and hardship.  The resulting austerity would be substantial and painful for the Greek people.

Consequently, the second policy option remains attractive: Staying in the euro zone while lessening the pain of doing so would be a win-win for the current Greek administration.  However, this policy options cannot be decided unilaterally, but instead relies upon the largesse of Germany.

  • Offering better bailout terms to Greece makes sense if it would effectively end the recession and restore economic stability, if not kindle positive growth.
  • One of the inherent difficulties in such a move, however, is the signal that such a change of policy would send to the Italians, French and Spanish, each of which are looking more and more Greek every day.
  • If Germany relaxes requirements for Greece, it seems likely that these other debt-laden countries would also sue for a better deal.
  • This becomes difficult because the money necessary to rescue economies as large as theirs just isn't there.

Source: Jagadeesh Gokhale, "Beginning of the End for the Euro?" Cato Institute, June 6, 2012.

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