Following its recent elections, the government of Greece has requested a “haircut” or reduction in the interest rate it must pay on the 320 billion euros in debt it owes to the European Central Bank (ECB). Greek banks have also asked the ECB for a bailout which, for the moment, it is denying. Much of this drama will ultimately be resolved by political forces rather than economics.
Many reporters and economists are wondering if the ECB will “save Greece,” by which they mean the ECB will provide some type of bailout. I would argue, however, that the ECB has already saved Greece by taking away its ability to print money.
When a country joins a monetary union, one of the downsides from the government’s perspective is that they lose the ability to conduct their own monetary policy. But let’s face it: most countries are not good at conducting their own monetary policy. Even in the United States, the Fed has not improved economic outcomes, and central banks in smaller countries often do much worse. Countries like Argentina continually inflate away their debts, resulting in lasting long-run inflation, preventing economic development and reducing foreign investment.
If Greece had the ability to conduct its own monetary policy, that’s exactly what it would be doing right now. Rather than haggling with the ECB over debt forgiveness, the Greek central bank would just print as much money as needed to pay its debts. A short-run default would be avoided, but Greece would pay serious economic consequences in long-run.
Because monetary policy is handled by the ECB, the Greek government is constrained in its ability to run perpetual deficits. Even if the country can’t balance its budget, Greece will at least be forced to reduce the growth in government spending to a level that is sustainable, for the time being. Yes, the current debate over ECB bailouts has important implications for Greece’s economy and it’s relation to the EU, but these battles are minor in the long-run.
The bigger battle has already been won. By taking away the ability to monetize its debts, the ECB has already saved Greece.