Emiliano Brancaccio

Ricerca, didattica e divulgazione
Research, teaching and media

Technical conditions for Grexit

translated by Revolting Europe, 22 February 2015

by Emiliano Brancaccio and Gennaro Zezza

You cannot say that between 2010 and 2014, Greece has not “done their homework” assigned by the Troika. The tax burden has grown by five percentage points of GDP, public spending has fallen by a quarter and wages have fallen by twenty percentage points. The European Commission has always maintained that these policies would not have depressed the economy and would have boosted competitiveness. But its Greek GDP forecasts have been repeatedly been wide of the mark: the collapse of production in Greece showed a gap compared with the estimates of Brussels that sometimes exceeded the embarrassing figure of seven percent of GDP.

Furthermore, despite the reduction in costs and wages, the results on competitiveness were different from expectations: the balance with respect to foreign countries has improved, but much due to a collapse in income and imports than a bounce back in exports. Nor can we say that the policies set by the Troika have stabilized budgets: the budget deficit was reduced laboriously but the drop in production has meant an explosion of the ratio of government debt to GDP of more than thirty percentage points. The Greek case, mind you, is extreme but does not in any way constitute an exception. It represents the clearest confirmation of the forecast of Economists’ Warning published in September 2013 on the Financial Times: instead of stabilizing the eurozone, the current European policies feed a debt deflation, accentuate the differences between the countries of Northern and Southern Europe and bury the chances of survival of monetary union.

Many commentators believe, however, that a return to the drachma would be even more damaging to the Greek economy. The implication is that the new government led by Alexis Tsipras has no alternative: after the catwalk in Europe and meetings with Renzi and Juncker, eventually the Greek prime minister will have to settle for modest concessions on debt that Brussels will be willing to offer.

But is it really true that Greece has no cards to play? In fact, the scientific literature on the costs and benefits of a possible abandonment of the euro provides controversial results. The point on which economists agree is that the success or failure of a return to national currencies would depend ultimately on the ability or otherwise of Greece to boost demand and domestic production while maintaining in balance imports and exports. If it can control the balance of trade, Greece would reduce its dependence on international loans, and thus have a better chance to manage the difficult transition. The problem is that the crisis has destroyed an important part of the productive base of the country, so a possible stimulus to the demand for goods is likely to cause a large increase in imports and the foreign trade deficit.

Interesting ideas in this regard, can be drawn from the model for the Greek economy developed by the Levy Economics Institute, which has been more accurate in its forecasts than the major international institutions. The model shows that the current improvement in the foreign account already provides maneuvering space for an expansionary policy. Within the budget constraints of Europe, however, the stimulus would be insufficient to raise the GDP and employment appreciably. Consider then the hypothesis that in the absence of European support to relaunch the Greek economy, in 2015 Greece defaulted on its debt and returned to the drachma, adopting an expansionary fiscal policy of up to 10 billion.

With pessimistic assumptions on the devaluation of the drachma and its impact on the prices of imported goods, the model predicts a substantial increase in GDP but also a modest improvement in exports, and in the short term a worsening picture for imports. The consequence would be a foreign deficit of up to five billion Euros – about three percent of GDP – which would decrease slowly thereafter. How would Greece manage the period of increased external deficit? How would it contain it? Would there be countries willing to finance it?

These are crucial questions, for Tsipras but also for the whole of Europe. Whoever is under the illusion that the case of Greece is isolated has already had a reality check with the domino effect of past years. If the Greek government was cornered, and at that point deemed that it were able to handle a possible exit from the euro, this would have inevitable repercussions on Italy, on Southern Europe and on the overall resilience of the monetary union.

Emiliano Brancaccio (Sannio University) and
Gennaro Zezza (University of Cassino and Levy Institute)


Originally published by Il Mattino (3 February 2015). Translated by Revolting Europe (22 February 2015).