An exit roadmap for leaving the Euro Zone - PowerPoint Presentation

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An exit roadmap for leaving the Euro Zone

Pedro Cosme Costa VieiraFaculdade de Economia do PortoPublic Finances and the Eurozone Economies: Past, Present and Future Perspectives ConferencePorto, 9-10 December 2011

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Introduction

Money exists to be an interpersonal unit of value and to mediate transactions among different economic agents. Being so, it is useless to have a currency area with just one person.2Slide3

Introduction

When there is an increase in CA dimension there are decreases in currency conversion costs and exchange rate uncertainty.3Slide4

Introduction

Then, it seems logical that the agglutination of several countries in a single CA would be a stimulus to the economic growth and to the convergence of marginal countries to those more prosperous ones.4Slide5

Introduction

Nonetheless, historical data does not point toward this logical conclusion. Nowadays almost every country has a different currency evolving this status quo from the failure of the Gold Standard (that used Gold as an almost global currency).5Slide6

Introduction

WHY THAT?-> Economics issues-> Cultural issues6Slide7

Introduction

-> Economics issuesWhen, in the business cycle, there is an unfavorable exogenous chock, its consequence will be asymmetrical among countries. 7Slide8

Introduction

-> Economics issuesThen, those countries more severely affected must decrease nominal wages and prices or will suffer a severe current account deficit (that must be financed by the other countries). 8Slide9

Introduction

-> Cultural issuesPeople have heterogeneous preferences. Due to age, academic knowledge, culture background and whatever, people have different time preferences, awareness to inflation and tolerance to nominal wages decreasing. 9Slide10

Introduction

-> Cultural issuesIn the long term, those people that prefer the present more intensely (which equilibrium interest rate would be higher) run into debt and their country goes into bankruptcy.10Slide11

Introduction

-> Cultural issuesIn the short term, when there is an unfavorable exogenous chock, some countries from the EZ prefer to lower nominal wages while other prefer to increase the inflation. 11Slide12

Introduction

-> Cultural issuesThe actual EZ sovereign crisis indicates that European cultural differences overpass economic similarities (e.g., Glavan, 2004).

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Introduction

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The setup of the Euro Zone

-> The design of EZStability Pact identified that some countries could run into debtPublic deficit <3% and public debt <60%As countries are sovereigns and have vote, the compliance with the pact became voluntary.14Slide15

The setup of the Euro Zone

Initially, 1998-2005, it seemed that Euro Zone was OK because The interest rates were identical all over the Euro Zone. 15Slide16

The setup of the Euro Zone

But, during 1998/2005, surreptitiously countries started a diverging path. The current account accumulated:Portugal (-66%), Estonia (-61%), Greece (-50%)Luxemburg (+77%), Finland (+41%), Netherland (+32%) and Belgium (+31%).

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The setup of the Euro Zone

This continued till nowIn international dollars, 1998-2010 it accum.Spain (-485G€), Greece (– 250G€), Italy (-210G€) and Portugal (– 200G€)Germany (+980G€), Netherland (+300G€),Finland (+105G€).

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The setup of the Euro Zone

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The cost for leaving Eurozone

We must separate the exit problems from the bankruptcy problem.The cost does not arrive from the leaving the EZ but from the bankruptcy process19Slide20

The cost for leaving Eurozone

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The cost for leaving Eurozone

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The cost for leaving Eurozone

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The Roadmap

A new currency for each exiting countryReintroducing the old currencyA pre-announced processA double currency area23Slide24

The Roadmap

1.st step – month 1.The announcement that the country will exit the Euro Zone and the publication of this roadmap. 24Slide25

The Roadmap

2.nd step - month 4.a) Denomination of prices, wages, pensions and social benefits in Euros and in local currency, LCU; b)Denomination of 60% of the value of all other contracts in LCU and remaining 40% in Euros.

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The Roadmap

2.nd step - month 4.c) Bank deposits, bank debts and financial contracts continue denominated in Euros.This is key to maintain the free movement of capital.

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The Roadmap

3.th step – month 7.d) Reintroduction of the LCU using the same bank notes used prior to the entrance in the Euro Zone. e) Reinstate of the Local Central Bank. Inter-banks market interest rate

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The Roadmap

4.th step – month 13.f) Adoption of a crawling peg to Euro exchange rate regime with a monthly constant rate of depreciation of 0.75%/month.For a 30% devaluation it will be necessary a 4 years transition period.

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The Roadmap

5.th step – end of the sliding crawling peg.g) Adoption for the new currency of the floating exchange rate regime Then, exchange rate variability will be low (probably).29Slide30

A plan for the bankruptcy

PIIGS are unable to roll-over their debtIt is impossible that Germany, Netherland, Finland and Luxemburg guarantee PIIGS’ debts. Then, PIIGS would relax and GNFL would be required to pay those debts.

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A plan for the bankruptcy

On the maturity date the bonds are substituted by new bondsInterest rate:Germany 10 years bonds yield + 1 p.p.Revised annually (variable interest rate)

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A plan for the bankruptcy

Currency of denomination:That of Germany on the payment dateMaturity:50 years32Slide33

A plan for the bankruptcy

The country must compromise to have a surplus sufficient to pay the interests and to amortize the debt in those 50 years.33Slide34

A plan for the bankruptcy

Repayment simulation Debt: 120% of the GDP Interest rate: 3.8%/year GDP growth: 1.6%/yearThe country must have a surplus of 4% of the GDP

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A plan for the bankruptcy

A surplus of 4% of the GDP is a feasible numberI = 5.0%/year -> 5% surplusI = 7.1%/year -> 7% surplus

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Conclusion

Our decease is an inevitability. The exit of PIIGS from the Euro Zone is certain.Then, we must prepare it.In this presentation I indicate a roadmap.36Slide37

Conclusion

The exit from the EZ will have no disadvantages or costs.For those bankrupted countries it will be necessary to reschedule the actual external debt .

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This is the end

Thank you for your attention.38