Thursday, September 30, 2010

Eichengreen and Temin on the challenges of redenomination

The gold standard was preserved by an ideology that indicated that only under extreme conditions could the fixed exchange rate be unfixed.  

The euro has gone one step further by eliminating national currencies.  Modifying the policy regime unilaterally is
even more difficult than under the gold standard.  

While it is conceivable, in theory, that an incumbent member of the euro area could opt to reintroduce its national currency and then depreciate it against the euro, there is no provision for doing so in the Lisbon Treaty.  

It similarly is conceivable that an incumbent member might choose to disregard its treaty obligations.  But, even then, if the decision to reintroduce the national currency and convert all the financial assets and liabilities of residents into that unit was not done instantly, a period of extreme financial instability would follow, as investors withdrew their money from the domestic banking system and financial en masse, creating ‘the mother of all financial crises’.  

This spectre raises the question of whether the operation can be done at all, parliamentary democracies not being good at taking decisions overnight.

("Fetters of Gold and Paper", Eichengreen and Temin)

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