Thinking About the All Too Thinkable

Paul Krugman

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originally published in the New York Times JUNE 18, 2015

The path toward non-Grexit — toward Greece and its creditors reaching a deal that keeps it in the euro — is getting narrower, although it’s not yet completely closed. I’ve been reticent on the subject, for fear of adding my bit to the crisis atmosphere, and I still intend to keep it cool. But there are a few things that seem to need saying.

First, the first line of defense against euro exit has been overrun. Way back when Barry Eichengreen made an argument many of us found persuasive, namely that no country would dare even hint at leaving the euro because such a move would trigger “the mother of all financial crises” as everyone raced to pull funds out of banks. As some of us noted, however, this would become moot if the financial crisis and bank runs happened in advance, Argentine style, forcing the imposition of capital controls and other measures.

As it turned out, the Argentine scenario was headed off by the political determination of elites to stay in the euro and the success of the ECB’s “whatever it takes” declaration of willingness to act as lender of last resort. But the reprieve wasn’t permanent; in this respect, at least, Athens 2015 is Buenos Aires 2001. Financial stability is already greatly compromised, so the costs of thinking about the formerly unthinkable have fallen.

How did we get to this point? Nothing fills me with quite as much despair as the persistence of the story line that it’s all about continuing Greek fecklessness, that the Greeks haven’t done anything. In fact, Greece has imposed almost inconceivable pain on itself. Here’s a comparison between Greece and Spain, the current favorite son of the austerity camp (although the Spaniards themselves aren’t impressed):

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European Commission

The problem has been that severe spending cuts in an economy with no independent monetary policy and no ability to devalue lead to severe economic contraction, which in turn means that a large part of what’s gained fiscally at the front end gets lost via reduced revenue. This isn’t the fault of the Greeks, it’s basically a design flaw in the euro itself.

So what about Grexit? At this point quite a few people on the creditor/Troika side of the negotiations seem almost to welcome the prospect. But this is bizarre in terms of their underlying interests. Yes, the lives of the officials would become easier, for a while, because they wouldn’t have to deal with Syriza. But from the point of view of the creditors, Grexit would be a pure negative. They would almost surely receive less in payments than they would under any deal that keeps Greece in, and the proof that the euro is in fact reversible would grease the rails for future crises, even if the ECB is able to contain this one.

And as Martin Wolf points out, Greece will still be there, and will still need dealing with.

The Greeks, on the other hand, should feel conflicted. There would probably be a lot of financial chaos in the immediate aftermath of euro exit. And maybe the apocalyptic warning from the Bank of Greece that devaluation would push the nation back into the Third World is right, although I’d like to know about the model and historical examples that would justify this claim. But absent that kind of implosion, a devalued currency should eventually produce an export-led recovery — I understand the cynicism one hears, but demand curves do slope downwards even in Greece.

The point is that nobody should be casual or confident here. But the creditors should actually be even more worried than the Greeks about a potential exit that has no upside for the rest of Europe.

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