“Greece will default on its national debt. That default will be due in large part to its membership in the European Monetary Union. If it were not part of the euro system, Greece might not have gotten into its current predicament and, even if it had gotten into its current predicament, it could have avoided the need to default.
There simply is no way around the arithmetic implied by the scale of deficit reduction and the accompanying economic decline: Greece’s default on its debt is inevitable.
Greece might have been able to avoid that outcome if it were not in the eurozone. If Greece still had its own currency, the authorities could devalue it while tightening fiscal policy. A devalued currency would increase exports and would cause Greek households and firms to substitute domestic products for imported goods. The increased demand for Greek goods and services would raise Greece’s GDP, increasing tax revenue and reducing transfer payments. In short, fiscal consolidation would be both easier and less painful if Greece had its own monetary policy.
Greece’s membership in the eurozone was also a principal cause of its current large budget deficit. Because Greece has not had its own currency for more than a decade, there has been no market signal to warn Greece that its debt was growing unacceptably large.
If Greece had remained outside the eurozone and retained the drachma, the large increased supply of Greek bonds would cause the drachma to decline and the interest rate on the bonds to rise. But, because Greek euro bonds were regarded as a close substitute for other countries’ euro bonds, the interest rate on Greek bonds did not rise as Greece increased its borrowing – until the market began to fear a possible default.”
Martin Feldstein, Professor of Economics at Harvard University
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