This is not a question with an easy answer but, nevertheless, I will attempt to provide one even though I am not an expert in this particular area.
The first part of the answer has to do with Greece’s short-term prospects. If Greece stays within the Euro zone, it will have more access to funds through its European partners given that, admittedly, they have no other choice. Default may be delayed, but it is mathematically inevitable. If Greece exits the Euro either on its own accord, in order to return to the drachma and devalue it, or due to eventual pressure from its partners, the Greek debt that was issued in Euros will cost multiple times in drachmas. Greece will then default with a bang. The impact on the Greek banks holding Greek debt and their access to capital is also quite uncertain then. Not to mention that a return to the drachma would be political suicide for any government. Entry into the Euro zone was sold as one of Greece’s biggest achievements that, unlike the drachma, offered stability and membership to an elite club of economically advanced countries.
The second part of the answer has to do with Greece’s longer-term prospects within the Euro zone, once default (to any degree of severity) has occurred and enough time has passed so that Greece has regained access to credit markets. Is it to the net benefit of Greece to be in the Euro zone in the long run? Well, did Greece benefit from being in the zone before the crisis erupted? Greece arguably enjoyed lower interest rates for its sovereign debt and more access to credit than it would have faced otherwise. This affluence of credit in fact led to Greece’s current troubles. On the down side, entering a currency union in which the joint currency appreciated about 40% because of the strength of Greece’s Northern European partners did have a significant effect on Greek exports. At this point, let me mention again that I still cannot comprehend why the Germans are in favor of a strong Euro, unlike the Americans who are implementing a weak dollar. I do understand that protecting the value of one’s accumulated wealth in Euros is important, but I do not comprehend the German fear of inflation or the fixation on a strong Euro. To begin with, the last time I checked, the German output gap was negative. In all, if market forces drive the Euro down in the long run, which should happen once the US economy really turns around, I am inclined to vote for Greece staying in the Euro zone.
October 15, 2011, update: I respectfully disagree with Charlie Calomiris and Stergios Skaperdas. A return to a seriously devalued drachma will likely cause rampant inflation that will hinder the ability to print more money, which defies the logic for going back to the drachma. Stay in the euro zone and reduce the labor costs instead to increase competitiveness.
November 6, 2011, update: Add Costas Azariadis to the list above of economists in favor of returning to the drachma.
It makes no sense to me why Europe is insisting on a strong euro and high interest rates, for fear of inflation, given the weakness in European periphery and the sovereign debt crisis. A strong euro and high interest rates may be beneficial to some robust economies of the north, but it has a significant negative impact. I understand that northern countries want to maintain the value of their accumulated wealth, but the strong dollar is affecting exports and the high interest rates are affecting investment, consumption and the chances of a recovery. Can’t the Europen leaders and the ECB comprehend why the US is doing the exact opposite?
Read Krugman’s article in the New York Times.
Read the interesting New York Times article: It’s not about Greece anymore.
Do markets know best? You may argue so. What the Europenas did not do by themselves through their common monetary and interest rate policy, the markets have done for them. Given the state of the European economy as a whole and the problems facing the PIIGS, one might argue that the euro should have been devalued against the dollar some time ago. Isn’t this a blessing for German exports too?