Paul Krugman has a thoughtful op-ed piece in today’s New York Times in which he reluctantly calls for Greek exit from the euro. I share his view on the desirability of Grexit at this juncture, but not his reluctance in expressing that opinion. How could Grexit best be designed, for Greece, for Europe, and for international interests? Below are a few modest thoughts on this.
1. The European Union (through the EFSF) should agree to accept payment on its holding of outstanding Greek sovereign debt in drachma. The agreed swap from euro into drachma debt payments should be set using some reasonable income-based metric. So, for example, the debt-payment exchange rate could be set so that the Greek debt/GDP ratio is 80%. The debt payment swap should not be based on the market’s drachma/euro exchange rate, since this would leave the Greek debt burden unsustainable. Greece should emerge with a modestly high, but sustainable, sovereign debt burden in drachma. The debt payment exchange rate should be GDP-linked going forward, not tied to the market’s euro/drachma rate, but with the option for the Greek government to switch back to the originally-contracted euro payments if it so wishes (not likely). This is a tricky design problem, but there is no immediate rush in completing it. A few weeks or months of debt payments can easily be rolled over until the plan is finalized.
2. The European Union or EFSF should make good on Greece’s debts to the International Monetary Fund. The IMF was wrong to allow its capital to be misused in the 2010 bailout, but it should not, and probably would not, accept anything less than full payment without exacting painful retribution against Greece. IMF capital is intended to aid financially-distressed emerging markets in sovereign debt crises rather than to bail out private-sector banks in Europe.
3. The domestic assets and liabilities of Greek banks will need to be redenominated into drachmas, at a rate that is sustainable for private and business debt within Greece. The redenomination of bank liabilities (savings and demand accounts) will contribute to the capital flight risk of peripheral euro-area banking systems. That is a euro design problem which is not solved. Pretending Grexit does not need to happen is not a viable solution to this unsolved euro design problem.
4. I am not sure what mechanism or rate the ECB should require on drachma repayment of outstanding euro-denominated Emergency Liquidity Assistance.