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Kashyap: Eurozone Breakup Still Possible

February 07, 2013

One or more countries could well quit the eurozone within the next two years, Anil K Kashyap said at Chicago Booth’s Economic Outlook 2013 in London.

Kashyap, Edward Eagle Brown Professor of Economics and Finance at Chicago Booth, said there were a number of potential triggers for a “collapse” of the single currency area.

The immediate threat was that reforms in Greece “destroyed” the political support for the government in Athens, forcing it to abandon the measures demanded by the European Union and International Monetary Fund as part of the bailouts.

“I don’t know how long you can run a country when the youth unemployment rate is at 50 percent, but I think we’re going to find out soon in Greece,” Kashyap said.

In Germany, the campaign leading up to elections later this year could ratchet up the pressure on chancellor Angela Merkel to impose tougher conditions if another eurozone country such as Cyprus needs a bailout, a move that would unnerve other indebted countries.

The most likely trigger of a eurozone breakup would be the exit of a stronger country, Kashyap said. “If you get out and your currency appreciates, the economics of the problem become much less.”

He said public appetite in Finland for further bailouts was very limited. “They sit next door to Sweden and Norway, who live happily outside the euro area. You ask them what they have in common with the Spanish, Italians, and Greeks, and they look at you like you’ve got three noses.”

He put the probability at “a little over 50 percent” that either Finland would leave voluntarily or one of the weak countries would drop out by 2015.

“If Finland did go out of the euro, what’s to stop other strong countries from saying ‘Hey, why don’t we do that?’ Once someone has done it then the costs for everyone else would be much lower.”

Kashyap said at some point there needs to be an honest discussion about the cost to the strong countries of supporting the weak ones. “Part of the problem is that politicians keep pretending that all of this is free and that no one has to pay for it,” he said.

According to Kashyap, the bigger eurozone economies should hold referenda to give their citizens a choice of whether to keep the euro project intact, and leaders should explicitly spell out the costs of not doing so. “Were that to happen, I think it would be pretty easy to keep the whole thing together, but the politicians have this view that you can’t handle the truth,” Kashyap said.

Phil Thornton