You cannot get out of a depression through austerity. Need I say more?
According to the Financial Times, Merkel wants to make the new bail-out conditional on Greece giving up fiscal sovereignty to a “budget commissioner” with veto power who is to be appointed by the eurozone finance ministers. Without knowing the precise details, of course, it is too soon to evaluate this possible proposal, however, one is left wondering, first, if this is really necessary and, second, if it is constitutional. Besides, the issue at hand is that the Greek government cannot implement reforms fast enough because of resistance by special interest groups and unions. How is a budget commissioner going to help with reforms outside the public sector?
Watching the Greek news daily on (satellite tv) has convinced me of a communication issue. Admittedly the Greek government has its hands full with the PSI “haircut” and the troika demands. But it assumes that the average citizen knows enough economics to realize that the only choices right now for boosting competitiveness are exit from the euro and serious devaluation of the drachma or euro retention and serious internal devaluation, unfortunately through substantial reductions in labor costs. As we argued in earlier postings, even though this comes down to a political decision, economists would mostly agree that staying in the euro is more beneficial for the long run, unless Greece ends up having no choice. If clever journalists cannot get this, why does the government assume that everyone else can?
Ioannides and Pissarides are against going back to the drachma. Read their Kathimerini article (in Greek).
If Greece went back to the drachma, the impact on the banking system would be catastrophic, in my opinion. Who would Greek banks borrow from, and how would they get any deposits? Gresham’s law dictates that people will be saving in euros and will be transacting in drachmas, at least outside of black markets. The euros will be hoarded or will be deposited to other European banks. Who in his right mind would be depositing euros in Greek banks if a mandatory conversion to drachmas could not be ruled out completely?
On one hand I hope that the haircut is not a credit event, but if a 50% haircut does not trigger the CDS, I am wondering why would anyone buy heavily into the debt of any country facing a non-negligible probability of default.