What's Next for the Euro? The Eurozone Faces a Choice Between the Plague and Cholera

The chaotic situation following the most recent parliamentary elections in Greece make the country’s departure from the eurozone appear more likely. In this interview, ZEW's President Wolfgang Franz shares his views on the future of the euro.

Professor Dr. Dr. h.c. mult. Wolfgang Franz has been the president of ZEW since 1997 and holds a chair in economics at the University of Mannheim. He is the head of ZEW's Growth and Business Cycles research department. His research interests include macroeconomics, labour markets, and empirical economics research. Prof. Franz is a member of the German Council of Economic Experts, and has been the chairman of this group since 2009.

What would happen if Greece announced tomorrow that it was departing from the eurozone?

Greece would actually like to remain in the currency union, but if a new Greek government refuses to implement the adjustment measures that have been agreed upon, the financial aid that has been promised by the EU and IMF will be cut off. The Greek state would no longer be able to honour its payment obligations and the country's banking system would collapse. The ECB would be unable to help and Greece would be forced to reintroduce its own currency, which would only be worth half of the euro, according to some estimates. In any event, the consequences for Greece would be severe. The prices of imports would increase dramatically, consumption and investment would collapse, and savers would have to accept huge losses. Increasing exports – for example, in the tourism or transport sectors – would hardly counterbalance these ill effects.

How would Europe react?

The EU would help Greece, as it would not be possible to sit on the sidelines and do nothing. Assistance would be expensive and would come on top of the 80 billion euros for which Germany is already liable in the event of Greek insolvency (based on the bailout packages and Greece's TARGET2 liabilities). In addition, Greek insolvency might have contagion effects for other troubled countries. In this regard, however, the firewalls between countries are stronger than before and the European banking system as a whole is better prepared than it was two years ago.

Would the euro be able to survive over the long term if it was split into an economically strong north and economically weak south?

Such regional differences in economic strength are not cast in stone. Just ten years ago Germany was considered the 'sick man of Europe' and Italy had a thriving economy, despite some problem areas. Regional disparities were even visible within Germany prior to the adoption of the euro. Economic heterogeneity within the eurozone could be reduced through greater labour mobility and targeted EU structural funding.

What makes more sense: For the weaker countries to leave the eurozone or for the stronger countries to do so?

That is a choice between the plague and cholera. If the 'stronger' countries introduced a 'northern eurozone', for example, it would not take long for financial markets to test the strength of weaker members, to see if they would better suited in the 'southern eurozone'.

How does the architecture of the common currency need to be changed in order to place Europe's economies back on solid footing over the long term?

In this regard we need an effective regulatory framework that ensures sound public financing and a stable financial system. As soon as they come into effect, both the European Fiscal Compact and Stability Mechanism will go a long way in achieving this, which is not to say that criticism of certain details has been unjustified. However, the crucial matter at present is to extricate ourselves from the current mess by building a bridge toward a stable regulatory structure. To this end, the German Council of Economic Experts has proposed a debt repayment pact.