■ The most realistic scenario for the break-up of the euro is that one or more of the weaker peripheral countries will leave the euro zone, introduce a new currency, which then falls sharply, and default on a large part of their government debt. Other forms of break-up are possible, but the analysis of these will involve the same issues, although, in the case of strong countries leaving, often with the signs reversed. Accordingly, our analysis centres on the departure of a single weak member, and we then note any instance where the issues and conclusions need to be modified for other forms of break-up.
■ It will not be possible to be open about preparations to leave for more than a very short period without precipitating a damaging outflow of money, which could cause a banking collapse. Accordingly, preparations must be made in secret by a small group of officials and then acted on more or less straight away.
recommend that the country should immediately announce a regime of inflation- targeting, monitored by a body of independent experts, adopt a set of tough fiscal rules and outlaw the indexing of wages but announce the issue of index-linked government bonds. The government should also continue with structural reforms designed to increase the flexibility of product and labour markets.
■ To facilitate the convenient use of euro notes and coins, to help to maintain price transparency, and to boost confidence in the new system, we recommend that the new currency be introduced at parity with the euro. Accordingly, where a price used to be 1.35 euros it would now be (for example) 1.35 drachmas. The drachma would be free to fall on the foreign-exchange markets, and indeed it is vital that it should do so.
■ We reckon that when any or all of the weaker members of the euro zone left, their currencies would depreciate by something like 30 to 50 per cent. This would add another 10 per cent to consumer prices, or even more, which, spread over two years, would cause the annual rate of inflation to rise by roughly half this figure. But international experience suggests that such a spike can be short-lived, and inflation can then return to something like its previous level.
■ Given the short time from announcement to implementation, it will not be possible to have new notes and coins available immediately. This is unfortunate, but it is not as serious as is often imagined. The authorities should allow euro notes and coins to continue to be used for small transactions; but immediately after the decision to abandon the euro has been announced they should commission new notes and coins to be produced as soon as possible.
■ To facilitate the convenient use of euro notes and coins, to help to maintain price transparency, and to boost confidence in the new system, we recommend that the new currency be introduced at parity with the euro. Accordingly, where a price used to be 1.35 euros it would now be (for example) 1.35 drachmas. The drachma would be free to fall on the foreign-exchange markets, and indeed it is vital that it should do so.
■ We reckon that when any or all of the weaker members of the euro zone left, their currencies would depreciate by something like 30 to 50 per cent. This would add another 10 per cent to consumer prices, or even more, which, spread over two years, would cause the annual rate of inflation to rise by roughly half this figure. But international experience suggests that such a spike can be short-lived, and inflation can then return to something like its previous level.
■ Just before the changeover, some form of capital controls will be essential, including at least the closure of the banks. But after the changeover, capital controls should be avoided and, if used, should be withdrawn as soon as possible.
■ The government should redenominate its debt in the new national currency, and make clear its intention to renegotiate the terms of this debt. This is likely to involve a substantial default—perhaps enough to reduce the ratio of debt to GDP to 60 per cent. But the government should also make clear its intention to resume servicing its remaining debt as soon as practically possible.
■ The central bank of the country should stand ready to inject liquidity into its own banking system, if necessary by quantitative easing. The monetary authorities should also announce their willingness to recapitalise the banks if necessary.
■ The authorities should provide as much clarity as possible on the legal issues, including the status of the country’s membership of the European Union and the effect on international contracts at present denominated in euros. Approval by the EU would also be needed for any capital controls, but this would have to be sought retrospectively. All this would require close co-operation with other EU member- states and institutions, including countries in the northern core.
■ Domestic economic policy may also have to adapt. Indeed policy-makers in the northern core should have more freedom once they are no longer constrained by the need to set an example for weaker countries that have left. As the value of the euro would rise, the northern core would at first suffer from a loss of domestic demand, though it would enjoy a lower rate of inflation. This combination would give it the incentive to undertake measures to boost domestic demand, especially through monetary policy and structural reforms.
■ A rebalancing of the economy away from reliance on net exports would be in the interests of the whole of the present membership of the euro zone, as well as countries outside it.
Of course, giving up the euro without breaking from the dominance of neo-liberalism would result in further significant hardship for ordinary people, as the price of imported goods, especially food, would increase. Austerity would not just go away either; so repudiating the debt would be necessary in order to force the highest possible write-down. This would allow social measures and strategic economic investment to be given priority, rather than paying the bondholders, and for the people of this country to be put first.
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