Greece: a simple macroeconomic guide

In reading this, which I will come back to, I thought something short and simple was required

In 2010 periphery Eurozone countries, including Greece, faced two problems: government deficits were too high, and as a result their economies had become uncompetitive. (Excessive deficits - public or subsequently socialised private - had allowed the economy to run too hot which pushed up inflation leading to a loss of competitiveness.)

The deficits needed to be reduced. Under flexible exchange rates this could have been done with relatively little cost in terms of unemployment because competitiveness could have adjusted to its appropriate level immediately via a nominal depreciation. The demand lost from lower public spending could be compensated for by more competitive exports. In a monetary union, this cannot happen, so a period of unemployment is inevitable to restore competitiveness.

The key macroeconomic question is how quick adjustment should be. Should competitiveness be restored quickly or slowly. Macroeconomics has a pretty clear answer which comes from the Phillips curve (of whatever variety) - slow is much more efficient. So it makes sense for some institution like the IMF to provide loans to the government to allow it to eliminate deficits gradually. There are lots of political and social reasons to make adjustment gradual as well, but this is just about the macro.

Those are general principles. When it came to Greece, the Eurozone made three key mistakes.

1)    Too much austerity too quickly, violating the logic of the previous paragraph. Sharp austerity can almost appear self-defeating in deficit reduction terms, as it plunges the economy into severe depression, making adjustment of any kind more difficult. The Troika has to take direct responsibility for this mistake.

2)    There was only partial (and delayed) default on Greek government debt (see below). This was clearly not in Greece’s interest, but it had benefits to other Eurozone countries.

3)    Adjustment was required in an environment of Eurozone recession and deflation, caused by needless fiscal austerity in the non-periphery countries. Restoring competitiveness is much more difficult if the countries you are adjusting with respect to have very low/zero inflation (because people resist nominal wage cuts).

That is the past, but it has direct implications for today. (2) means that the Troika were demanding Greece ran large primary surpluses in the coming years to pay back the remaining debt and adjustment loans. This makes correcting the error in (1) much more difficult, because it implies yet more austerity. In terms of macroeconomics it is a clear mistake. (If Greece could eliminate its negative output gap, it would be running a primary surplus of over 7% according to the OECD, which would be enough for everyone.)    

Now back to this Vox piece. It displays so much that is wrong with macro arguments coming out of the Eurozone at the moment. Examples:

a.    “For an economy in the dismal Greek situation, it essentially made no difference that it remained a member of the Eurozone ..” This ignores the basic macro in the second paragraph above. This denial of the importance of wage and price rigidities, which leads to the key cost of being part of a monetary union, has typified the Eurozone project from the start.

b.    “Since in all these cases painful adjustment was inevitable and costly, one should take the combination of the rescue packages and adjustment programmes as what they really are – a device helping to avoid a sudden fiscal and current account adjustment with even larger immediate pain.” It is of course true that with access to markets cut off, adjustment without any support from the IMF or elsewhere would in macro terms have been much more immediate and painful. But the implication is that the speed of adjustment matters, and in particular that it can still be too fast. The article makes no attempt to address this central issue. The message that comes across to Greece is that you should be lucky you got something.

c.    “During the past five years Greece indeed underwent serious reforms and fiscal consolidation. Progress has been remarkable …” What is remarkable is the extent of the collapse in the Greek economy. Some kind of recession was inevitable, but not a complete collapse in GDP, where over half of young people are unemployed. The article tries to suggest that this is just par for the course, rather than a function of the amount of austerity imposed.

d.    “A debt relief of public creditors could not substantially improve the comfortable state of the Greek government, let alone be justified easily vis-à-vis its lenders.” This is disingenuous. It is true that the effective interest rate on Greek debt is relatively low compared to other Eurozone countries, but nevertheless the lenders are demanding Greece run significant primary surpluses now, and they need not make this demand. 

I could go on and on, but this is meant to be short. To sum up, the problems displayed by this article amount to a neglect of the importance of wage and price rigidities, and the impact that fiscal austerity can have on demand leading to a needless waste of resources. In other words, a denial of basic Keynesian ideas.  

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Ditulis oleh AndreSurbakti pada tanggal Sabtu, 21 Februari 2015