by Arnab Das and Nouriel Roubini
April 2, 2012
The European Central Bank has averted disaster, sparking a powerful relief rally – but nothing fundamental has been resolved. Greece may need another debt restructuring; Portugal and Ireland may need restructuring too. Spain and Italy may yet come under the gun. Banking crises are hardly ever resolved without removing toxic assets or recapitalisation. The eurozone still lacks essential features of monetary unions that have stood the test of time; and planned reforms may exacerbate latent fiscal, banking and external imbalances, leaving it less, rather than more, resilient to regional shocks.
Splitting up may be hard to do, but it can be better than sticking to a bad marriage. The periphery debt crisis threatens to engulf the core in huge bank capital shortfalls and fiscal liabilities, trapping both in protracted stagnation. This reflects possibly intractable eurozone design flaws. So we propose the following amicable divorce settlement.
Countries leaving the eurozone must rebalance away from growth led by debt, towards export- and income-led growth. Members of a “rump” eurozone should rebalance toward domestic demand. The EU free trade arrangement is critical to this end. Ideally, five distressed peripherals – Portugal, Ireland, Italy, Greece and Spain – would exit, negotiating bridge financing.
Currency realignment would aid this adjustment. It is far better to restore competitiveness through devaluation than by changing relative prices with a fixed nominal exchange rate, which implies protracted debt deflation, potentially ending in disorderly defaults and exits in any case, or sustained inflation above target in surplus countries. There would of course be disruption even in a cooperative, partial dismantling of the currency union, but it would be in everyone’s interest to minimise the damage by adhering to the agreed exit strategy.