Drachma

Countries tempted to abandon the European currency face formidable barriers says Barry Eichengreen.

If the ongoing credit crisis is the most serious economic shock to hit the world economy in 80 years, then it is certainly also the most serious problem to confront the euro area in its inaugural decade. It is precisely the kind of “asymmetric shock” warned of by early euro-skeptics and highlighted by the theory of optimum currency areas.

Treaty obligations

Beyond that, a country that unilaterally abandoned the euro to “steal” a competitive advantage would jeopardize its status as a member in good standing of the EU. It would not be welcomed at the table where EU policies are discussed. The Lisbon Treaty (admittedly yet to be ratified) contains a clause under which countries can conceivably exit the EU. But there is no clause concerning exit from the euro. The implication is that in order to quit the euro the country would also have to quit the EU, thereby abrogating the entire range of treaty obligations to its fellow member states.

It would be straightforward for a parliament or congress to pass a law mandating that the state and other employers would henceforth pay workers and pensioners in the new national currency. But with wages and other incomes redenominated into that national currency, it would become necessary to redenominate the mortgages and credit card debts of residents into the national currency as well. Currency depreciation would otherwise have adverse balance sheet effects for households, leading to financial distress and bankruptcies.

But with mortgages and other bank assets redenominated, bank deposits and other bank balance sheet items would have to be redenominated as well to avoid destabilizing the financial sector. With government revenues redenominated into the national currency, not just public sector wages and pensions but also other government liabilities, notably the public debt, would have to be redenominated to prevent balance-sheet effects from damaging the government’s financial position.

 Barry Eichengreen is George C. Pardee and Helen N. Pardee Professor of Economics and Political Science at the University of California, Berkeley. Read more at http://www.imf.org/external/pubs/ft/fandd/2009/06/eichengr.htm
 

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