The euro: no soft landing on exit

by Jean Pisani-Ferry

Bruegel
September 12, 2011

It may appear pointless to switch to summer time each year when it would be simpler for everyone to decide to come into work one hour earlier in the morning. Yet we all change the clocks because it is much easier to put back your watch than to change your habits.

One hears this same rationale increasingly often for arguing that the countries whose competitiveness has nose-dived should leave the euro. Rather than hoping that, by the combined effect of tens of millions of independent decisions, firms and workers would force themselves painfully to absorb past price and wage inflation, it would, according to some, suffice to recoup competitiveness by reducing the exchange rate of the new national currency by the requisite percentage.

Monetary experience in fact teaches that, for the same final result, an internal devaluation (by a change in prices and wages) is much harder to achieve than a devaluation of the exchange rate. But, even if one disregards the European political stakes of such a decision, this logic sins by omission on several counts.

The first obstacle is legal. The EU Treaty provides for a voluntary exit clause from the Union, but not from the euro. Thus a state may leave the Union (and thereby forfeit regional aid, considerable for Greece and Portugal, and CAP transfers), but there is no provision for leaving the euro and remaining in the Union.

The second obstacle is technical. It is straightforward to change currency in a financially underdeveloped country: just order a stock of brand new notes. But it is quite another matter in a modern economy. Years of preparation and adjustment of IT systems went into the switch to the euro, followed by a lengthy test phase. Leaving the euro abruptly would inevitably be costly and disruptive.

The third obstacle is economic. The proponents of exit claim that a controlled devaluation of the new currency is to be anticipated. This is to overlook that the countries likely to go for this option are labouring under a credibility gap. If there are new national currencies, it is the market which will determine what they are worth. When Argentina severed its fixed link to the US dollar in January 2002, the government announced a new exchange rate of 1.4 pesos to the dollar (instead of one peso). In July, there were four pesos to the dollar: the currency had lost three quarters of its value.

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A version of this column was also published on Le Monde (in French)