An exit roadmap for leaving the euro zone
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An exit roadmap for leaving the Euro Zone. Pedro Cosme Costa Vieira Faculdade de Economia do Porto Public Finances and the Eurozone Economies: Past, Present and Future Perspectives Conference Porto, 9-10 December 2011. Introduction.

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An exit roadmap for leaving the euro zone

An exit roadmap for leaving the Euro Zone

Pedro Cosme Costa Vieira

Faculdade de Economia do Porto

Public Finances and the Eurozone Economies:

Past, Present and Future Perspectives Conference

Porto, 9-10 December 2011


Introduction
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.


Introduction1
Introduction

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


Introduction2
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.


Introduction3
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).


Introduction4
Introduction

WHY THAT?

-> Economics issues

-> Cultural issues


Introduction5
Introduction

-> Economics issues

When, in the business cycle, there is an unfavorable exogenous chock, its consequence will be asymmetrical among countries.


Introduction6
Introduction

-> Economics issues

Then, 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).


Introduction7
Introduction

-> Cultural issues

People 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.


Introduction8
Introduction

-> Cultural issues

In 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.


Introduction9
Introduction

-> Cultural issues

In 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.


Introduction10
Introduction

-> Cultural issues

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



The setup of the euro zone
The setup of the Euro Zone

-> The design of EZ

Stability Pact identified that some countries could run into debt

Public deficit <3% and public debt <60%

As countries are sovereigns and have vote, the compliance with the pact became voluntary.


The setup of the euro zone1
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.


The setup of the euro zone2
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%).


The setup of the euro zone3
The setup of the Euro Zone

This continued till now

In international dollars, 1998-2010 it accum.

Spain (-485G€), Greece (– 250G€),

Italy (-210G€) and Portugal (– 200G€)

Germany (+980G€), Netherland (+300G€),

Finland (+105G€).



The cost for leaving eurozone
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 process





The roadmap
The Roadmap

A new currency for each exiting country

Reintroducing the old currency

A pre-announced process

A double currency area


The roadmap1
The Roadmap

1.st step – month 1.

The announcement that the country will exit the Euro Zone and the publication of this roadmap.


The roadmap2
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.


The roadmap3
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.


The roadmap4
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


The roadmap5
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.


The roadmap6
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).


A plan for the bankruptcy
A plan for the bankruptcy

PIIGS are unable to roll-over their debt

It is impossible that Germany, Netherland, Finland and Luxemburg guarantee PIIGS’ debts.

Then, PIIGS would relax and GNFL would be required to pay those debts.


A plan for the bankruptcy1
A plan for the bankruptcy

On the maturity date the bonds are substituted by new bonds

Interest rate:

Germany 10 years bonds yield + 1 p.p.

Revised annually (variable interest rate)


A plan for the bankruptcy2
A plan for the bankruptcy

Currency of denomination:

That of Germany on the payment date

Maturity:

50 years


A plan for the bankruptcy3
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.


A plan for the bankruptcy4
A plan for the bankruptcy

Repayment simulation

Debt: 120% of the GDP

Interest rate: 3.8%/year

GDP growth: 1.6%/year

The country must have a surplus of 4% of the GDP


A plan for the bankruptcy5
A plan for the bankruptcy

A surplus of 4% of the GDP is a feasible number

I = 5.0%/year -> 5% surplus

I = 7.1%/year -> 7% surplus


Conclusion
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.


Conclusion1
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 .


This is the end
This is the end

Thank you for your attention.


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