Vox
October 2, 2011
One of the many proposals for escaping the Eurozone crisis is to follow in the footsteps of Argentina since its currency fiasco a decade ago. This column points out the realities of such a path: regressive wealth transfers and debt dilution. Against this dismal backdrop, a fiscal union might well be a better option.
The European predicament is:
- Financial (large debt stocks); and
- Real (large fiscal and current-account flow gaps).
A solution to just one of these is likely to be inadequate. A solution, for example, that focuses solely on debt restructuring will fail if not complemented with a plan to recover price competitiveness and growth to fix the real problem.
Eurozone leaders fail to show the political will to move to a fiscal union (the missing piece in the euro puzzle) and insist on an ‘internal devaluation’ (fiscal adjustment and big wage cuts). This trajectory looks politically unfeasible and economically self-defeating. In this context, euro exit is getting increased attention as a means of boosting external demand while avoiding painful nominal cuts. Martin Feldstein, for instance, has suggested that Greece take a ‘holiday’ from the Eurozone and re-enter with a depreciated nominal exchange rate (see Feldstein 2010 and Baldwin and Wyplosz 2010). This column argues that this idea is not just impractical, it’s dangerous for the Eurozone.
The comparison that is continually referred to is Argentina’s 2002 devaluation. Many economists point to the country's swift recovery and systematic outperformance – even relative to its South American neighbours that benefited from historically high terms of trade – and attribute the results to the newly gained competitiveness from a depreciated exchange rate (see for example Blejer and Yeyati 2010, Cavallo and Cottani 2010, and Cavallo 2011). But to what extent was the devaluation boost really about competitiveness?
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