Conventional wisdom has it that Greece’s economic woes are worse because the country is part of the eurozone. Were it not for the euro, Greece would have had a monetary policy of its own and could have spend instead of cut its way out of recession. Right?
Economist Paul Krugman is particularly hostile to the euro, blaming the continent’s policy elite for supposedly “pushing” their countries into adopting a single currency well before they were “ready” for such an experiment. The inflexibility of the euro, according to Krugman, “not deficit spending, lies at the heart of the crisis.”
The euro may be “inflexible” on the surface, with northern politicians demanding that Greece and other heavily indebted southern economies enact deep budget cuts, but the European Central Bank has quietly maintained a fairly expansionary monetary policy with very generous lending programs for European banks.
Had Greece still a currency of its own, it’s highly unlikely that it could have maintained an even more expansionary monetary policy without incurring greater risk than is evident today. Unless the country tried to inflate its way out of debt, it would have faced the possibility of bankruptcy much sooner.
If Greece had been able to drive up inflation and thus make it easier for the state to make good on its debt obligations, the Greek people would have suffered the consequences. Austerity may be tough but hyperinflation is a lot tougher. Especially as it would almost inevitably have ended in sovereign default.
The reintroduction of a national currency wouldn’t avoid that. In fact, it would accelerate default as the original debt was contracted in euros and a new drachma would presumably have to be dramatically depreciated, meaning Greece’s debt burden grows.
A weak drachma could boost exports temporarily but superfluous regulations and red tape currently do far more to impede Greek exports than the value of the euro. Being part of the currency union actually makes it easier for the Greeks to trade within Europe.
The problem hasn’t been that the euro is too much of a straightjacket for Greece. The problem is that the fiscal arrangements that were designed to maintain stability across the eurozone — the debt and deficit limits embedded in the Stability and Growth Pact — were unenforceable, allowing Greece, and other countries, to overspend for many years and amass lethal amounts of debt. Ejecting them from the eurozone wouldn’t solve their problems. It would expose European banks and pension funds to the risk of losing their investments in Greek government bonds.