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Greece’s Catharsis?

ATHENS – Sunday’s election in Greece will decide whether confrontation or negotiation will be used to change the terms of Greece’s refinancing agreement with the eurozone. Rather than helping Greece to overcome its crisis, the austerity policies pursued since May 2010 have plunged it into a deep recession that perpetuates fiscal deficits and aggravates financial uncertainty.

It is becoming increasingly clear that if Greece proceeds to unilateral action – whether by repealing unpopular austerity laws or renouncing the loan agreement itself – the eurozone will suspend disbursement of the loan. The government will find it impossible to fulfill basic obligations, such as paying salaries and pensions, and the country will formally default. International banks will cease to finance Greek enterprises, including imports, creating shortages of fuel, food, and medicines. As confidence that Greece will remain in the eurozone plummets, a run on deposits will cause the banking system – and, eventually, the real economy – to collapse.

The next step will be forced exit from the euro and reintroduction of the drachma, implying a dramatic drop in living standards, owing in part to immediate devaluation of the new currency and high inflation. Meanwhile, the benefits in terms of competitiveness will be very limited, owing to the country’s narrow export base, and will evaporate in a vicious circle of devaluations and rising interest rates.

Long-term stagnation and high unemployment are the likely result of confrontation with the eurozone, which leaves only the path of renegotiation. The new political balance emerging in Europe after the Socialists’ victory in France’s presidential election creates scope for changes in the terms of the loan agreement that would help to boost economic growth.