A Greek exit from the euro area would inflict heavy damage in Greece and throughout Europe. It could also be one of the best things that ever happened to the currency union.
Greece’s repeat parliamentary election next month will serve as a referendum on whether the country should end its 12- year membership in the common currency. An affirmative answer would trigger a cardiac arrest of the Greek economy, as the banking system collapsed and foreign suppliers refused payment in drachmas. The financial system of the euro area, by far Greece’s biggest international creditor, would suffer hundreds of billions of euros in losses.
For the European economy as a whole, the primary danger would be the reintroduction of currency risk into what has been billed as an irrevocable monetary union. When Greek banks collapse, or have to be closed for a prolonged holiday to facilitate a forced conversion of deposits into new drachmas, one cannot predict whether citizens and firms across the periphery of Europe will pull their money out of their banks just in case. The result could be financially disastrous.
The potentially dire repercussions have led many to assume that no responsible European policy maker would allow a Greek exit to take place. By this view, all the talk about letting Greece leave is merely a scare tactic. Europe’s leaders will blink first in their game of chicken with Greece and ease the terms of the country’s austerity program.
This logic underestimates a crucial element of the euro area’s political economy: In a union of partially sovereign members without a supranational authority, concerns about moral hazard — the possibility that lenience toward Greece will encourage other countries to misbehave — still carry a lot of weight. Euro-area leaders are not bluffing when they threaten to cut off support from the European Central Bank and let the Greek government run out of money, leaving it to decide whether to dump the euro or remain as merely a euro-ized country such as Montenegro.
What Europe’s leaders will not countenance is a breakup of the euro. Therein lies the silver lining of a Greek exit. To protect the currency union from the fallout, the remaining members will have to move very quickly toward the economic and financial integration that has always been necessary for the euro’s long-term survival.
Such is the nature of the European Union and the history of regional integration: It is propelled by bouts of acute crisis. Make-or-break moments are what shape the boundaries of the politically possible and inspire leaders to do whatever it takes to save the euro.
Consider, for example, how Europe might respond to the threat of bank runs. Only some kind of pan-euro deposit- guarantee program would be authoritative enough to persuade people to keep their money in the banks of peripheral countries such as Portugal, Spain and Italy. Initially, German Chancellor Angela Merkel and ECB President Mario Draghi could make the commitment orally. Putting the program in place, though, would require a quantum leap in the integration of euro-area banking supervision and regulation. Control over banks in the area would have to be transferred to the supranational level. In other words, a euro-area banking union could emerge as the direct result of a Greek exit.
The catastrophic economic repercussions in Greece — which would be very visible for electorates in other countries — would have a consolidating effect on the euro area. It would demonstrate the limits of bailouts and the consequences of irresponsible behavior, alleviating the risk of moral hazard in the remaining member states. No peripheral electorates would want to emulate Greece’s experiences. Northern taxpayers would be satisfied that their financial support was neither unlimited nor unconditional. As a result, the thorny politics of fiscal- integration projects, such as the introduction of euro-area bonds, would become much easier to handle.
Beyond that, losing Greece would relieve one of the euro area’s biggest problems: Its member economies have been too out of sync to share a common monetary policy. The departure of the most economically and politically challenged member would allow the remaining 16 members to act much more like a unit.
Ultimately, only deeper integration among the remaining euro-area members could re-establish the notion that the currency union was irrevocable after a Greek exit. Fortunately, that’s precisely the response Greece’s departure would be most likely to produce.
Jacob Kirkegaard is a research fellow at the Peterson Institute for International Economics.
