My proposal begins with government action to write down the value of all euro-denominated contracts enforced within Greece. This “redenomination” would make all existing contracts – wages, pensions, deposits, and loans – legally worth only, say, 70% of their current nominal value. This policy would kill several birds with one stone. It would significantly reduce pensions, relieving fiscal pressure and satisfying troika demands for fiscal sustainability. It would do so in a way that would also mitigate the purchasing power consequences for pensioners, because an across-the-board redenomination would lower prices throughout the economy, making the reduction in nominal pensions more bearable. By applying redenomination to deposits and loans, banks’ health would be revived – their loans would now be payable and therefore more valuable, and their net worth would consequently rise. The 30% wage reduction would further reduce fiscal problems and make Greek producers competitive, and operate as an “internal devaluation” to raise demand for Greek products and tourism. Most importantly, this internal devaluation – by solving the problems of fiscal deficits, non-competitiveness and bank insolvency – would inspire confidence in Athens’ ability to stay within the eurozone, which should bring deposits back into the banking system to fuel a rebirth of lending.I think this is about half right, but a very good idea lies in here.
"an across-the-board redenomination would lower prices throughout the economy"? Not necessarily. Why would any store lower prices just because it gets to lower wages and rent? Prices are not a "contract."
Thus, the redenomination should probably come with a (say) one week price control. Every price must be lowered 30% over what it was the previous day, for a week, Just long enough for each store to see that its competitors and suppliers has also really lowered prices. Then stores can do what they want.
The deeper issue here is just what is the price and wage stickiness that so infects macroeconomic thinking. Why is "internal devaluation" by price and wage adjustment so much harder than "external devaluation" by exchange rate adjustment? Our formal models have costs of changing prices. Yet the actual costs of changing prices are tiny.
I think a "coordination problem" is more likely. The baker doesn't want to lower his price because he still pays the same price for wheat and yeast; the farmer doesn't want to lower his price because he pays the same price for fuel, and so forth. This web of prices is of course thousands of times more complex than that story. That's why it takes so long for everyone to agree on lower prices together.
At times, however, prices and wages do change, overnight, with no cost at all. When countries join the euro, every store changes price -- and the symbol next to it -- overnight. That fact alone should tell us that menu costs, though a nice formalism, are not the real microeconomic foundation of price and wage stickiness. And there is a potential role for a government to coordinate price changes.
What Charles is proposing, then, is exactly the same sort of overnight price and wage change that happened on admission to the euro. If you think prices and wages are "overvalued" in Greece, and a "devaluation" is all it takes for Thessaloniki to start exporting Porsches to Stuttgart, then an overnight, coordinated, price and wage change is a very nice alternative policy that we might start taking more seriously.
This is a bit of a "thesis topic" suggestion. I think we need a model of price stickiness as a coordination failure that is as simple and tractable as the standard, but false, Calvo fairy or menu cost models. Coordination failure models might also result in the sort of backward-looking stickiness that Phillips curves in the data seem to show.
Why just a week? Well, the macroeconomic presumption here is that Greece is suffering some sort of "imbalance" or "overvaluation" or "sticky wage." If that's right, one week at the right prices and wages should stick. Each individual store or person would then be reluctant to raise prices without the others going along. If prices jump right back up again after a week, however, without the help of government coordination, then we weren't so imbalanced to begin with, and the problem is really structural not monetary.
I rather suspect that tourist prices are set by competition with Sicily, not local wage stickiness, but it would be interesting to see. Prices of imported goods will also likely jump right back up. Fine.
Charles doesn't mention prices, but he does mention debts. This is a lot harder, as a debt "redenomination" is not just a method to solve a coordination problem and lower all prices and wages relative to German ones going forward, it is a huge transfer of wealth and a technical default.
If you run a coffee shop and charged 2 euros for a cappuccino yesterday, having all the coffee shops change to 1.5 euros overnight (for a week) is one thing. But changing the mortgage payment is another. One is a price. The other is a default.
Charles sneaks off into the economic passive voice here "By applying redenomination.." which is always a sign of trouble ahead. Most lenders, especially international ones, will go straight to court on that one.
I also do not follow how "applying redenomination to deposits and loans, banks’ health would be revived – their loans would now be payable and therefore more valuable, and their net worth would consequently rise." Before redenomination: Assets: 50 euros mortgages, 50 euros greek government bonds. Liabilities: 99 euros deposits, 1 euro equity. After redenomination: all numbers cut by 1/3. How is the bank any healthier? All ratios (capital, leverage) are the same.
So I think the proposal has the right spirit but a slightly wrong focus.
Although redenomination would accomplish a great deal, by itself it is not enough. As simple economic theory (formally known as the the Balassa-Samuelson Theorem) tells us Greece will only be a viable long-term member of the eurozone if it can match the long-term productivity growth of Germany and other members. To do so requires it to undertake major reforms to labor laws and competition policies, and to wage a credible war on corruption.I disagree pretty strongly here. If "eurozone" means a free trade agreement and a common currency, that can survive just fine with vastly different productivity levels (it already does) and consequently different productivity growth rates. Productivity across locations in the US varies enormously. Ricardo and absolute vs. comparative advantage was all about free trade under the gold standard (common currency) between countries of different "competitiveness" or productivity levels. Perhaps he means eurozone as an area that promises fiscal transfers to produce an equal standard of living everywhere. If so, good luck.
But that Greece's only hope to avoid becoming the next Venezuela is "major reforms to labor laws and competition policies, and to wage a credible war on corruption" is spot on. In or out of the euro, in our out of the EU, in the end money and trade freedom are small parts of economic growth.