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As the Economist notes, other countries have defaulted in the past (Argentina, Russia, Indonesia) and then only suffered a temporary growth penalty.

So perhaps in some cases it is worthwhile to default on your debt now, at the expense of being locked out of capital markets for a few years, if you can avoid stringent budget cuts.

As I have argued, there is a disconnect in this debate about short run and long run effects of cutting budgets during a recession. It will stimulate business growth, but only in the medium or long run, but in the short run it has a negative stimulatory effect. It reduces government demand whilst private sector demand remains weak.

So defaulting is a good idea, if you can guarantee that the government is willing to make strong structural changes to your budget once private sector demand starts flowing again. The problem is that this guarantee is almost never available.

So, if Greece defaults now to avoid its budget cuts, is it realistic that the Greek government will make these necessary cuts in two or three years time? If it doesn’t, then the same structural budget problems remain with the Greek economy. No lender would lend to Greece, if it has defaulted and has not fixed the problems that lead to the default in the first place.

I think the best solution, which the Economist has been advocating for some time, is to restructure Greece’s debt by long-dating some of its current debt obligations. The debtors need to take a small haircut.

I would add that Greece needs to be moved out of the common currency. The drachma needs to be reinstituted as the Greek currency so that it can devalue, giving the Greek central bank the power to adjust is interest rates accordingly.


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