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A New Beginning for Greece – and Europe

If the Greek government does not credibly commit to structural reforms that are in the country’s own long-term interest, a voluntary exit from the eurozone would enable it to start anew. This would also impel the EU to pursue the fiscal and structural coordination needed to enable its monetary union to function properly.

KIEL – Greece is in urgent need of clear thinking. The only reason the country has not long since defaulted on its debts is that the European Central Bank continues to provide funds to the Greek central bank through its emergency liquidity assistance (ELA) scheme. The Greek central bank, in turn, lends money to the country’s commercial banks, which lend it to Greek citizens and foreign creditors. The problem is that both groups of borrowers have been transferring large sums of money to other countries.

The result is that overdraft credits to the Greek central bank have grown by nearly €1 billion a day in recent months. If Greece defaults and leaves the eurozone, these overdrafts will not be repaid.

ELA funding assumes that the Greek economy is temporarily illiquid, but not insolvent. This assumption is patently false. Despite all the pain Greece has suffered – a 30% drop in aggregate demand since the last cyclical peak and a rise in unemployment to more than 25% of the workforce – the Greek economy is still nowhere near competitive enough to repay its debts.

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