The Euro Exit
By Matthew Richardson, Charles E. Simon Professor of Applied Economics, Sidney Homer Director, Salomon Center for Research in Financial Institutions and Markets and Professor of Finance, Thomas Cooley, Paganelli-Bull Professor of Business and International Trade & Kermit Schoenholtz, Professor of Management Practice and Director of the Center for Global Economy and Business
If EMU policymakers wish to preserve the euro, they will need a Hamiltonian solution, including both fiscal burden-sharing to halt the crisis and conditionality (or fiscal and financial rules) to prevent another crisis and avoid a persistent wealth transfer to peripheral EMU members.
This Sunday, June 17, Greeks once again will go to the polls to elect a new leader. Unlike the past when elections were all about the right versus the left side of the political spectrum, this one is about whether Greece should stay in the European Monetary Union (EMU) and implement the necessary austerity. The threat of an imminent Greek exit from the euro is self-evident.
Unfortunately, policymakers in the eurozone underestimate how difficult it will be to hold the remaining euro area together if Greece exits. Greece is playing a massive game of chicken with its EMU partners, and could still win.
The reason is that the euro area was designed to be irreversible. The foundation of EMU, the Maastricht Treaty, makes no provision for exit. This commitment constitutes the critical difference between EMU and other fixed exchange rate regimes from which countries can (and routinely do) exit.
Fixed exchange rate regimes are inherently unstable in a world of free capital flows. To make them work, policymakers must commit credibly to act in the future in ways that will on occasion prove wildly inconsistent with their future preferences. Economists call this the problem of time consistency: making such commitments credible is not always feasible.
It is not as if Europe hasn't gone through this before.Read full article as published in The Huffington Post.