Why is Athens still refusing the free lunch of a Grexit?

With its own currency, Greece would be able to support its banking system and even engage in QE

It is widely accepted that a return to the drachma, involving a major fall in the exchange rate, would, on average, impose heavy costs on ordinary Greeks. This may indeed be widely accepted, but it happens not to be true.

There is a serious lack of understanding of the economics of devaluation – even in some surprisingly high places. What passes for wisdom on the subject is heavily influenced by the experience with fixed exchange rates, which the UK, and most of the world, gave up in 1971-72. In the classic cases, when countries resorted to devaluation it was because of a “balance of payments” crisis, an excess of imports over exports.

Typically, the economy was at full, often over-full, employment. Essentially, there had been a binge, involving rampant spending by governments or consumers, or both. Hence it would only be possible to boost exports and/or reduce imports to shrink the deficit by cutting government spending, investment or consumption. Accordingly, in many cases, including the devaluation of sterling in 1967, the drop of the currency was accompanied by spending cuts, tax rises and credit restrictions.

That undoubtedly resulted in lower average living standards. It had to: fewer resources had to be devoted to providing for domestic citizens so that more resources could be shifted into producing exports.

Look at it this way: if Greece manages to produce extra GDP as a result of a devaluation, who will enjoy the benefit? The answer is not foreigners. Greece does not need to export more without importing more. It is Greeks who would benefit.

So why does the Greek government not welcome Grexit with open arms? Actually, governments usually have to be forced into it. This is sometimes because they simply don’t understand the economics. Even when they do, they are fearful of the unknown and obsessed by matters of prestige. The politicians are stuck in Shakespeare’s fourth age of man: “Seeking the bubble reputation, even in the cannon’s mouth.” All of the above played a role in the classic case of the UK’s expulsion from the Gold Standard in 1931, and when the pound dropped out of the ERM in 1992.

In Greece’s current predicament I know what Keynes would advocate – and I also know what I would do. Default, reschedule, reorder, postpone, invite debt forgiveness, or whatever, as much as you like. But Greece desperately needs increased demand. And the only way of securing this is via a much lower exchange rate. That means Grexit. There are “none so deaf as those that will not hear”.

Full article: Why is Athens still refusing the free lunch of a Grexit? (The Telegraph)

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