A major point of leaving the monetary union, one would presume, would be for Greece to extricate itself from the single currency and switch to the new drachma, or similar. Talk of Greece leaving the eurozone has of course started up again after a Spiegel report last Friday. More importantly, it’s become more nuanced. Kenneth Rogoff is quoted in a Thursday Reuters story saying Greece should “take a sabbatical from the euro zone, do a massive currency devaluation and then re-enter at a later date.”
However, Bank of America Merrill Lynch currency strategist (and a former IMF economist) Thanos Vamvakidis, reckons devaluation never did much for Greece pre-EMU.
Here’s his thinking from a piece of Thursday research:
We have argued that half of the loss in price competitiveness during the last decade in the periphery is explained by the strength of the EUR and have warned that a strong EUR makes the required adjustment in the region more difficult … However, we have also noted that repeated devaluations in Greece during the pre-EUR period failed to have a permanent impact on growth, arguing that only structural reforms can have such an effect … Econometric evidence in this report supports the claim that devaluations do not have a sustainable growth impact on the Eurozone periphery. The evidence is for the past four decades (1971-2009), or the period before the adoption of the EUR (1971-1999). The sample includes Greece, Ireland and Portugal, which are the countries in the region currently in crisis, but also Italy and Spain, for comparison.
There’s a bit of economic modelling involved here, but we’ll skip to the conclusion:
In all cases, the results suggest no impact of devaluations on growth (Charts 1- 10). The responses of real GDP growth to currency shocks are small and not always positive, in both the whole period and the pre-EUR period. Moreover, we cannot reject the null hypothesis that the responses of GDP growth to exchange rate shocks are statistically different from zero, in all the countries in the sample. The accumulated responses suggest that Ireland is the economy that could benefit the most from devaluation, followed by Spain (Table 1) – although the lack of statistical significance calls for caution in drawing such conclusions. This evidence suggests that even if devaluation was an option for the Eurozone periphery, it would not have helped the region on its own to grow out of the crisis. Clearly, the results do not suggest that exchange rate policy does not matter. In our view, they point to the conclusion that exchange rate devaluations do not lead to permanent competitiveness improvements in rigid economies, such as in the Eurozone periphery. In this context, tail risk scenarios about EUR exit are misplaced. Structural reforms are the best bet to improve the periphery’s growth prospects, within or outside monetary union.
Not much for economic growth, maybe, but it probably does a hell of a lot for debt destruction.
