JP Koning makes the case that even if Greece were to leave the Eurozone and institute a new currency (call it the New Drachma), Athens would still not have independent monetary policy: if households and firms continue to post prices in Euros rather than New Drachmas, Greek monetary policy would not be able to affect the Greek economy. As JP explains:

“Consider what happens if the euro remains the economy's preferred accounting unit, even as Greek drachmas begin to circulate as a medium of exchange. No matter how low the drachma exchange rate goes, there can be no drachma-induced improvement in competitiveness. After all, if olive oil producers accept payment in drachmas but continue to price their goods in euros, then a lower drachma will have no effect on Greek olive oil prices, the competitiveness of Greek oil vis-à-vis , say, Turkish oil, remaining unchanged. If a Greek computer programmer continues to price their services in euros, the number of drachmas required to hire him or her will have skyrocketed, but the programmer's euro price will have remained on par with a Finnish programmer's wage.”

Thus, if the New Drachma is not adopted as the dominant unit of account, Greece would still be at the mercy of the ECB, and worse, now without any voice in ECB decision-making.

I think this story is largely correct, but I want to throw out a counterpoint for discussion, which perhaps demonstrates that leaving the Eurozone could benefit Greece.

Currency reform and rewriting of debt contracts
One of the most important actions a government takes when it institutes a new currency or a currency reform is to legally redenominate all old contracts (issued under domestic law) in the new currency. In particular: debt therefore becomes automatically priced in the new currency.

In American history, this occurred during Franklin Roosevelt’s 1933 “currency reform”, when the dollar was devalued relative to gold and gold clauses in existing contracts were invalidated. To quote from Amity Shlaes’ “The Forgotten Man: A New History of the Great Depression”:

“Next Roosevelt set to work invalidating gold clauses in contracts. Since the previous century, gold clauses had been written into both government bond and private contracts between individual businessmen. The clauses committed signatories to paying not merely in dollars but in gold dollars. The boilerplate phrase was that the obligation would be “payable in principal and interest in United States gold coin of the present standard of value.” The phrase “the present standard” referred, or so many believed, to the moment at which the contract had been signed. The line also referred to gold, not paper, just as it said. This was a way of ensuring that, even if a government did inflate, an individual must still honor his original contract. Gold clause bonds had historically sold at a premium, which functioned as a kind of meter of people’s expectation of inflation. In order to fund World War I, for instance, Washington had resorted to gold clause bonds, backing Liberty Bonds sold to the public with gold.

Now, in the spring of 1933, upon the orders of Roosevelt, the Treasury was making clear that it would cease to honor its own gold clauses. This also threw into jeopardy gold clauses in private contracts between individuals. The notion would be tested in the Supreme Court later; meanwhile, bond and contract holders had to accept the de facto devaluation of their assets. The deflation had hurt borrowers, and now this inflationary act was a primitive revenge. To end the gold clause was an act of social redistribution, a $200 billion transfer of wealth from creditor to debtor, a victory for the populists.” [Chapter 5]

Unfortunately I can’t find a citation right now, but I believe Argentina did the same thing when it replaced the austral with the peso; and that this relabeling almost always occurs during currency reforms.

Thus after a currency reform, the price of existing debt, at the very least, would be in the new currency.

Debt: the most important nominal friction?
And there’s a good argument to be made that the most important “sticky” price is the price of debt. Selgin’s “Less Than Zero”, Sheedy (2014), and Mian and Sufi's new book make this argument.

Debt contracts are almost always both (a) fixed in nominal, not real, terms and (b) not contingent on aggregate economic conditions. In perfectly complete markets, on the other hand, we would expect debt contracts to be state-contingent. Contracts would be written in such a way that (perhaps by tracking an inflation index and some index of real economic conditions) if inflation or economic growth increases, borrowers would pay more back to their lender; and if inflation or economic growth went down, borrowers would pay less. Both borrowers and lenders would ex ante prefer this type of arrangement, but transaction costs make such contracts prohibitively expensive.

For more intuition on this see Chapter III of Less Than Zero and the introduction to Sheedy’s paper. As for why this nominal friction may be more important than the traditional nominal frictions that economists worry about – that is, sticky prices and sticky wages – I would again suggest a look at Sheedy’s paper where he calibrates his model and finds that the central bank should care 90% about this nominal debt “stickiness” and 10% about traditional price stickiness. However, the relative importance of these two categories of frictions is very much still an open question.

If non-state contingent debt is indeed the most important nominal friction, than perhaps if Greece were to rewrite existing debt contracts when instituting a New Drachma, the new Greek central bank would have enough control over the nominal economy to pull Greece out of its depression.

(Of course, after the switch over to the New Drachma, Greek households and firms could – unless further legislation prevented them – write *new* contracts denominated in euros. JP’s Latin America pricing hysteresis example would seem to suggest that this is very possible.)

In short
To summarize, JP writes, “As long as a significant portion of Greek prices are expressed in euros, Greece’s monetary policy will continue to be decided in Frankfurt, not Athens.” While true, it is at least conceivable that a government-mandated relabeling of existing debt contracts (as has occurred historically during currency reforms) could ensure that debt prices, which are perhaps the most important prices, are no longer expressed in euros but instead in New Drachma.


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