Is there a new and good plan to exit the euro?

by on July 9, 2013 at 6:43 am in Economics, Uncategorized | Permalink

Ross Macleod, from ANU, has an idea:

Greece or any other country in the euro zone could easily reintroduce a national currency without generating the kind of financial and economic calamity envisioned so far—provided it got the mechanics right.

The key is to fix the initial amount of new currency to be issued while allowing the market to set the price at which the exchange takes place. In this scenario, the central bank would announce that it is willing to purchase euros from domestic banks, the Greek public and anyone else, using newly issued drachmas as payment. All such transactions would take place during a specified transition period and be entirely voluntary. This would not be an exercise in confiscation.

After the transition period, the Greek government would deal only in drachmas in its day-to-day financial transactions. Nobody would be forced to hold drachmas, but those wishing to transact with the government would need drachmas to do so.

At the start of the transaction period, the central bank would announce the initial rate at which it offered to exchange drachmas for euros, but it would explicitly make no promise about what the rate will be in the future. The initial rate would be entirely arbitrary, as indeed would the name of the new currency.

…The price offered for euros would be adjusted on a daily basis to generate sales of euro to the central bank of the required magnitude. Sales on the first day may well be zero. But as the offered buying price increased, gradually some people would be willing to have a gamble. Eventually a price would be found at which there were significant demand for the new drachmas. People would be taking the risk that the price of euros will increase in the future—that is, that the new drachma will depreciate.

One problem is that of credibility.  Even seeing a new currency, no matter what the plan, could cause people to think their bank accounts will be redenominated, leading to bank runs.

But more fundamentally, this plan does not do two things which any euro replacement plan must, if it is to have a positive (but also disruptive) impact:

1. Redenominate wages and prices in terms of the new medium of account, to achieve wage and price flexibility, and

2. Ease the government’s budget constraint, by redenominating and indeed lowering the real value of the government’s guarantee to the domestic banking system.

You might ask what pins down the value of the new currency and the answer has to be that the government accepts it for tax payments.  But to that extent the fiscal position of the government becomes worse because they are relieving liabilities and receiving in return an asset on which at best they break even.

Imagine the following plan: the Portuguese government creates a parallel currency by announcing that it will conduct some or all of its transactions in terms of the New Zealand dollar.  Let’s say they find some takers and indeed some Kiwi dollars flow into Portugal.  The country will then have two currencies, but neither problem #1 nor problem #2, as stated above, will be solved.

1 suntzuanime July 9, 2013 at 7:13 am

This plan doesn’t solve the immediate problem, yeah. It *only* solves the problem of being in the Euro, not the other problems that being in the Euro has already caused. Which means it may work better for countries that have not already been completely destroyed by Euro membership.

2 NK July 9, 2013 at 11:46 am

Well put.

What seems worrisome is that as the Greek government dramatically cuts down on waste and fires unneeded workers, it will cut taxes and destroy demand for the new Drachma 🙂

It is at least 99% certain that “allow any currencies and do nothing” would be work better than “best” thought out plans made by economists.
The only problem – for the government and Troika, not the citizenry – is that it’d be very difficult to collect taxes if people transacted in whatever currencies they wanted.

3 Ashok Rao July 9, 2013 at 7:22 am

What’s particularly new about this solution? I mean aside from literal details this mirrors what I imagine would be a standard exit from the Euro (creating chartal money etc.) and – as you mention – faces the same primary problem of bank runs.

Not sure I agree about point (1). To the extent stickiness emerges from menu costs and especially behavioral reasons (worker morale etc.) redenomination at a lower wage rate will not be nearly as much of a problem. And unless there’s some huge speculative drachma-demand, the cb can just create a high-denomination currency evading morale concerns by a high, nominal monetary base.

The point on menu costs is more contingent on tax collections, etc. and I’m sure there are many nonlinearities and perverse effects which I may have avoided. But once firms are forced to reprice labor, we can hope wages will at least move in the right direction.

And wrt to point (2), IF (1) is met (and that’s a big “if”), a one-time jump in the inflation target can erode real value of debt, no?

4 x July 9, 2013 at 7:28 am

Exiting the Euro makes no sense, since the best currency to use is the most stable one.

As for (1), simply cut wages and prices… (after removing any law forbidding that).

As for (2), that’s called a default.

In general, states just need to stop spending more than they earn, and then whether they use the Euro, the USD or gold they are going to be fine

5 Max July 9, 2013 at 7:31 am

I agree Tyler. Introducing a brand new currency doesn’t provide the same benefits that already having a currency would provide. It would be easy for Greece to introduce a new currency and stabilize the value: simply peg it to the euro. 1 drachma = 1 euro. But that still leaves the control of the Greek economy in the hands of the ECB, so it provides no immediate relief. It’s a solution to the next crisis, not the current one.

6 Jim July 9, 2013 at 7:37 am

The problem has nothing to do with any particular currency.

It has to do with the fiscal insanity of Government, and its fundamental inability to be responsible.

Putting a new coat of paint on the currency does nothing to address this.

7 dearieme July 9, 2013 at 8:09 am

In a country like Greece, just changing the pay of government employees into New Drachmas probably changes the pay of a large part of the employed population. How will the government decide on the new pay rates?

8 JWatts July 9, 2013 at 9:26 am

How will the government decide on the new pay rates?

Judging by past practices, I’d imagine raises for all civil servants, as well as, increased pension and disability benefits.

9 (Not That) Bill O'Reilly July 9, 2013 at 8:21 am

Similarly to Professor Cowen’s 2nd point, this also does nothing to ease the debt burden directly imposed on the government if it does not entail a forcible redonomination of sovereign debt.

Even more problematically, as long as outstanding debt is denominated in Euros, the Greek government’s continuing need for Euros creates a credibility problem in that no one will believe that they wouldn’t accept payment in that currency at tax time or whenever.

10 Rahul July 9, 2013 at 9:29 am

Has it been almost two years since Tyler was predicting the imminent exit of Greece from the Euro? How long can an endgame drag and still be called an endgame?

11 sam July 9, 2013 at 11:44 am

Tyler has never predicted a sharp exit. His prediction is closer to what this post is about- that gradually things will change until one day people wake up and Greece no longer uses the Euro. For example, (similar to the idea above) if people slowly adopted Greek bonds for currency.

12 Rahul July 9, 2013 at 1:24 pm

Well, its darn hard to catch Tyler in a corner, but here’s a summary of some of his past predictions:

September 12, 2011: “Maybe it’s “old news” by now, but the chances of the eurozone holding together have never looked smaller, even since two or three days ago. It’s clear, if anyone had doubts in the first place (I didn’t), that no eurobond and no major package of truly committal aid will be forthcoming.”

July 10 2011: “What will happen with Greece? In case you don’t know by now, I see the pessimistic scenario as more likely…..At some point along the way, democracy is likely to intervene: either Greek voters will refuse further austerity and foreign domination, or voters from northern Europe will send a clear electoral message that they don’t support bailouts. And there’s a good chance one or both of those events will happen before a broader European bank recapitalization can be achieved.”

Nov 23 2011: “I hear the market whispering in the ear of the Netherlands “get out of the eurozone, before it’s too late!” At this point all bets are off as to which country will be the first to bail on the arrangement. It could be virtually anyone but France.”

Nov 25 2011: “Is the end near? I am seeing reports of 7.7 on the Italian ten-year bond, over eight percent on the two-year bond, 6.5 percent on the six-month note, and so on…….Maybe these markets simply will shut down soon. There is so much talk about what the Germans should do, but I don’t see the viable options…..I don’t see anybody who has put a successful reform option on the table……”

13 Peter Schaeffer July 10, 2013 at 2:12 pm


My bet is that Greece won’t exit the Euro anytime soon, if ever. Public opinion polls in Greece show majority support for the Euro and the political class (inside and outside of Greece) is deeply opposed to Euro exit.

However, I don’t see a shred of evidence that Greece will turnaround either. The Troika will consistently fail to impose (sufficient) reforms on Greece and Greece has little internal desire for reform.

As a consequence, Greece will continue to run large deficits and IMF / ECB money will continue to be used to convert Greek private sector debt into public debt.

Given that Greece won’t be able to pay its bills for the foreseeable future, it will be living on handouts from Northern Europe for a long, long time. Germany will end up in a ‘transfer union’ and a ‘debt union’ whether they (the Germans) like it or not.

Of course, the Germans could draw the line and say ‘no more’. It won’t happen. There will always be some way to kick the can further down the slippery slope and into a large scale transfer / debt union.

Greece will simply be the Mezzogiorno of Europe (along with Portugal, Spain, and Italy). Of course, Greece could turns its economy around on a dime by exiting the Euro and defaulting on its debt. It won’t happen.

Here is an analogy. Would Argentina have ever left dollar parity (with the Peso) if the U.S. had promised (and delivered on) unlimited support for the Peso? We didn’t and Argentina had no choice but to devalue and default. That worked out rather well for Argentina. However, how many savers in Argentina would have agreed in 2002?

14 derek July 9, 2013 at 10:56 am

Your two things that it must do but doesn’t amount to fiat screwing over a large number of people. That is why they can’t do it and accomplish any semblance of support by currency users.

It won’t be over until there is nothing left to lose.

15 Yancey Ward July 9, 2013 at 11:00 am

The idea founders on the following, as Tyler notes:

All such transactions would take place during a specified transition period and be entirely voluntary

Few if any would, or should, believe this.

16 Jardinero1 July 9, 2013 at 11:20 am

The problem is that holders of Greek debt want to be kept whole. Greek issuers of debt can’t make good. The Greeks can either default outright or default via inflation of a new, non-euro currency. There is no other way out.

17 Peter Schaeffer July 10, 2013 at 2:13 pm


“There is no other way out.”

No. Germany can and will pay the bills. Germany shouldn’t end up with Greece’s debts, but will.

18 Jeff July 9, 2013 at 2:39 pm

As James Taranto’s Best of the Web column said a few days ago:

Go back to the Franc, Hank.
Revert to the Lira, Mira.

19 ojo July 9, 2013 at 3:45 pm

Catch–Only Drachmas for government transactions leads to even more dismal tax collections as people prefer to hold Euros.

20 Floccina July 9, 2013 at 5:07 pm

How about they just start paying and taxing in drachmas?

21 endorendil July 10, 2013 at 6:32 am

It is indeed a completely dumb plan. You create two currencies, one for government transactions, one for everything else. This is exactly what they have in Cuba, for instance. The idea that you can entice people into using the official currency by raising its value with respect to the one that people already use is just insane. What you’ll see is an entire economy going black-market, hiding any and all transactions in the “real” currency, and maintaining only a minimal amount of official transactions to appease the government. As government workers are paid in the worthless currency, they work very little or leave altogether. The state becomes less able to collect taxes and it becomes completely irrelevant to most people. It’s a recipe for a failed state.
In any case, the problem with the euro is that some countries never had a stable currency, and didn’t adapt politically, socially and economically – or not fast enough. I don’t think anyone seriously doubts that a stable currency is better than a fickle one that’s prone to big value swings, but it requires a different mindset when dealing with public and private finances. This is a learning process.

22 solarman July 11, 2013 at 4:24 am

If there is one thing worse than being in the Euro it is not being in the Euro and having to set up anew currency.

The Greeks are going through a very painful financial “re-alignment” with the rest of the Euro. It has involved collecting more taxes and shrinking the size of the inefficient state. Whilst they are having a tough time now if and when the Euro economy starts to grow rather than stagnate then hopefully the enterprising Greek citizens can think of ways to share in this growth.

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