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Election Watch

The case for a Grexit - An old nation needs a new monetary policy

July 3, 2015

On Tuesday, Greece became the first developed nation to default on a loan from the IMF. As it missed its payment, Prime Minister Alexis Tsipras announced that he would be holding a referendum for voters to choose whether to accept the austerity measures proposed by the country’s creditors. Banks in Greece have remained closed the entire week leading up to the referendum. The surprising announcement caused markets to slow, amid fear of an economic collapse in Greece. The proposed referendum also initiated a swarm of debate among economists and political pundits about what the ramifications of such a vote would be.

A “Yes” vote in the referendum would accept the proposed austerity measures. This would likely lead to a continuation of the status quo within the economic sphere, while leading to a political shift within Greek domestic politics. The European Central Bank (ECB) would continue to bail out the indebted nation, allowing it to retain access to international financial markets, and continue using the Euro as a currency. Accepting the conditions of lenders and prolonging the status quo would most likely lead to a continued recession in Greece, with the nation unable to stimulate the economy through government expenditures or spur trade through currency depreciation. A yes vote would also mean that Tsipras, who was elected on the platform of ending austerity and has urged voters to vote no would likely resign as Prime Minister, leading to the formation of a new Greek government.

A “No” vote on the referendum would be a political gain for the incumbent party, Syriza, and Prime Minister Alex Tsipras, preventing the austerity measures the party has stood up against. By rejecting the proposal, Greece would be made insolvent and ineligible for international loans. This likely would force Greece to abandon the use of the Euro (labeled by many a “Grexit”) and readopt its national currency, the drachma. With Syriza elected to parliament just five months ago, running on the platform of not adopting austerity measures, and the Prime Minister advocating for citizens to vote no, this route appears to be the likely future of the nation.

While in the short run, a no vote would have a detrimental impact on the Greek economy, the option might benefit the country in the long run. The sudden change in currency would cause chaos among businesses and banks while the country adapts to the use of the new, or old, monetary system. The sudden drop in the exchange rate would create incredible poverty with little assistance from the international community. However, once the country has established the use of its own currency, it will be able to use inflation to boost its exports and stimulate economic growth, a tool which was not available under the Euro.

The global impacts a bankrupt Greece would be arguably small. Greece accounts for less than 2% of the European Union economy, and only around 0.4% of the world economy. An insolvent Greece would have the largest impact on Greece’s creditors. This economic impact would trickle into other EU nations, and eventually to the United States and Asia, causing minor slowing in the global economy. However, a much greater risk for global economic stability is the possibility that a Grexit would trigger greater instability within Europe. Spain, Italy, and Cyprus all face massive debts, similar to Greece, and the possibility of any of these nations following Greece’s footsteps. While, as Stiglitz and Krugman predict, a rejection of the proposal may be the best option to Greece, the potential chain of events it may set off could have a much greater impact.

While heavily opposed by most European leaders, Tsipras’s “No” campaign has gained the support of two prominent Nobel-laureates, Paul Krugman and Joseph Stiglitz. In a column for the New York Times, economist Paul Krugman described how a sudden devaluation of the Greek currency “couldn’t create more chaos than already exists, and would pave the way for eventual recovery” while a yes vote would only maintain the failed economic policies of the past. Writing an op-ed for the Guardian, economist Joseph Stiglitz urged voters to vote no for a different set of reasons. Stiglitz argued that the creditors don’t actually need the money being demanded. Holding Greece to such a regimented pay regime is only a tool to force Greece to adopt austerity and “other regressive and punitive policies”. Stiglitz claimed that while a yes vote would lead to unending recession, a no vote would allow Greece to “grasp its destiny in its own hands,” in line with the country’s tradition of democracy.

In an interview with Deutsche Welle, a third Nobel-laureate, Christopher Pissarides, urged Greeks to vote to accept the conditions of lenders. Pissarides argued that a no vote would lead to a dead end, cutting off the countries options and pushing Greece further into recession, while a yes vote would bring both parties back to the negotiating table in order to create a plan to move forward.

Many of the arguments surrounding the referendum boil down to which option would benefit Greece more: retaining access to international financial markets, or gaining control over their own monetary policy. At this point, Greek citizens must choose either one option or the other. Since the beginning of the economic crisis, Greece has relied on international capital flows as a solution to its woes. To date, that strategy has not fixed the problem, only burying the country deeper in debt and failing to jumpstart the country’s stalled economy. Many Greek citizens have strongly stood against the austerity measures put in place as a condition of the bailouts, leading to the election of Tsipras’s party, Syriza. The current strategy has only hurt Greece, preventing citizens from creating the policies they want.

In order to actually fix this problem, a new strategy is needed, and this will have to involve an independent Greek monetary policy. With control over its own domestic economy, the country could potentially steer itself into better waters. While switching to a new currency would initially create chaos, with businesses rapidly struggling to set new prices, the long run scenario would help set the country on the right track. Prices in Greece would drop, causing exports to increase. Industries that had once been drowned out by the high prices that came with the adoption of the Euro would be revived. International tourists would suddenly see Greece as a cheap vacation alternative to neighboring Mediterranean nations. With an improved economy and bonds denominated in its local currency, Greece could use inflation as a tool to help lessen the burden of its debts, a tool that was not available within the Eurozone.

After many years under the same financial policy, with high access to capital flows, and austerity measures that are incredibly unpopular with the population, Greece needs control over its own monetary policy. Should voters refuse to accept the agreed austerity measures in the upcoming referendum, a Grexit would allow Greece the chance to set its own monetary policies, bolstering exports and using inflation as a means to lessen the burden of its debt. At this point, while no outcome is ideal, the ongoing process of austerity and bailouts has proved a failure time and time again. The referendum on Sunday gives voters the option to choose a new and potentially promising economic route, a route which would give the country the benefit of setting its own monetary policy while cutting the nation off from additional capital flows. While neither option is a foolproof solution, voting no on the referendum could prove the most beneficial in the long run.

Christopher Carson
Research Intern, Centre for Pubic Policy Studies
Completing a Master of Arts in International Affairs at George Washington University

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