1. Pedro Cosme Costa Vieira Faculdade de Economia do Porto Public Finances and the Eurozone Economies: Past, Present and Future Perspectives Conference Porto, 9-10 December 2011 1

2. Money exists to be an interpersonal unit of value and to mediate transactions among different economic agents. Being so, it is useless to have a currency area with just one person. 2

3. When there is an increase in CA dimension there are decreases in currency conversion costs and exchange rate uncertainty. 3

4. Then, it seems logical that the agglutination of several countries in a single CA would be a stimulus to the economic growth and to the convergence of marginal countries to those more prosperous ones. 4

5. Nonetheless, historical data does not point toward this logical conclusion. Nowadays almost every country has a different currency evolving this status quo from the failure of the Gold Standard (that used Gold as an almost global currency). 5

6. WHY THAT? -> Economics issues -> Cultural issues 6

7. -> Economics issues When, in the business cycle, there is an unfavorable exogenous chock, its consequence will be asymmetrical among countries. 7

8. -> Economics issues Then, those countries more severely affected must decrease nominal wages and prices or will suffer a severe current account deficit (that must be financed by the other countries). 8

9. -> Cultural issues People have heterogeneous preferences. Due to age, academic knowledge, culture background and whatever, people have different time preferences, awareness to inflation and tolerance to nominal wages decreasing. 9

10. -> Cultural issues In the long term, those people that prefer the present more intensely (which equilibrium interest rate would be higher) run into debt and their country goes into bankruptcy. 10

11. -> Cultural issues In the short term, when there is an unfavorable exogenous chock, some countries from the EZ prefer to lower nominal wages while other prefer to increase the inflation. 11

12. -> Cultural issues The actual EZ sovereign crisis indicates that European cultural differences overpass economic similarities (e.g., Glavan, 2004). 12

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14. -> The design of EZ Stability Pact identified that some countries could run into debt Public deficit <3% and public debt <60% As countries are sovereigns and have vote, the compliance with the pact became voluntary. 14

15. Initially, 1998-2005, it seemed that Euro Zone was OK because The interest rates were identical all over the Euro Zone. 15

16. But, during 1998/2005, surreptitiously countries started a diverging path. The current account accumulated: Portugal (-66%), Estonia (-61%), Greece (-50%) Luxemburg (+77%), Finland (+41%), Netherland (+32%) and Belgium (+31%). 16

17. This continued till now In international dollars, 1998-2010 it accum. Spain (-485G€), Greece (– 250G€), Italy (-210G€) and Portugal (– 200G€) Germany (+980G€), Netherland (+300G€), Finland (+105G€). 17

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19. We must separate the exit problems from the bankruptcy problem. The cost does not arrive from the leaving the EZ but from the bankruptcy process 19

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23. A new currency for each exiting country Reintroducing the old currency A pre-announced process A double currency area 23

24. 1. st step – month 1. The announcement that the country will exit the Euro Zone and the publication of this roadmap. 24

25. 2. nd step - month 4. a) Denomination of prices, wages, pensions and social benefits in Euros and in local currency, LCU; b)Denomination of 60% of the value of all other contracts in LCU and remaining 40% in Euros. 25

26. 2. nd step - month 4. c) Bank deposits, bank debts and financial contracts continue denominated in Euros. This is key to maintain the free movement of capital. 26

27. 3. th step – month 7. d) Reintroduction of the LCU using the same bank notes used prior to the entrance in the Euro Zone. e) Reinstate of the Local Central Bank. Inter-banks market interest rate 27

28. 4. th step – month 13. f) Adoption of a crawling peg to Euro exchange rate regime with a monthly constant rate of depreciation of 0.75%/month. For a 30% devaluation it will be necessary a 4 years transition period. 28

29. 5.th step – end of the sliding crawling peg. g) Adoption for the new currency of the floating exchange rate regime Then, exchange rate variability will be low (probably). 29

30. PIIGS are unable to roll-over their debt It is impossible that Germany, Netherland, Finland and Luxemburg guarantee PIIGS’ debts. Then, PIIGS would relax and GNFL would be required to pay those debts. 30

31. On the maturity date the bonds are substituted by new bonds Interest rate: Germany 10 years bonds yield + 1 p.p. Revised annually (variable interest rate) 31

32. Currency of denomination: That of Germany on the payment date Maturity: 50 years 32

33. The country must compromise to have a surplus sufficient to pay the interests and to amortize the debt in those 50 years. 33

34. Repayment simulation Debt: 120% of the GDP Interest rate: 3.8%/year GDP growth: 1.6%/year The country must have a surplus of 4% of the GDP 34

35. A surplus of 4% of the GDP is a feasible number I = 5.0%/year -> 5% surplus I = 7.1%/year -> 7% surplus 35

36. Our decease is an inevitability. The exit of PIIGS from the Euro Zone is certain. Then, we must prepare it. In this presentation I indicate a roadmap. 36

37. The exit from the EZ will have no disadvantages or costs. For those bankrupted countries it will be necessary to reschedule the actual external debt. 37

38. Thank you for your attention. 38