German intellectuals on the offensive

VoxEU just published an article by various German economists defending Germany’s hard stance on Greece here.

They begin by noting the staggering size of the Greek deficit in 2009/10 (15% of GDP, 10% net of interest payments), and go on to say: “Given these fundamentals there was only one policy option – Greece had to balance its budget, and the current account needed to be turned into a surplus, to be able to service both its private and public debt.”

Wait hold on, this may sound absolutely nuts, but is that an automatic given? Yes, Greece needed stop its debt to GDP ratio from exploding, but does this immediately imply a balanced budget? We know that a balanced budget is not necessarily needed to maintain a steady or even declining debt to GDP ratio, as long as the economy experiences normal growth. On the other hand, Greece does not control its own money supply, thus it would have no independent monetary means of curtailing the rapid rise on interest rates it would suffer if were to try and continuously roll over its high level of borrowing. So, true, perhaps if you’re constrained by a currency union and lenders have so little faith in you, the very high interest rates would make maintaining a budget deficit infeasible.

Perhaps then, the rational response to this problem is to suggest not that an economy as weak  as Greece should engage in immediate heavy austerity, and risk a catastrophic fall in output, in order to maintain a surplus. Rather, perhaps Greece should leave the Eurozone in an orderly fashion, regain monetary sovereignty, engage in rational structured default of its external foreign denominated debts, and attempt to start again with a more accommodating monetary policy.

Of course, the risk in this case is a catastrophic rise in the price level. The authors however don’t do enough to explain why one risk is preferable to another, and what the risk of the latter actually is.

The paper continues to note that other countries that have experienced currency crises, regardless of whether they managed to defend a fixed exchange rate or not, also suffered deep slumps in output and a change from current account deficit to current account surplus. I struggle to see the relevance of this, a country entering a recession will inevitably experience a decrease in its current account deficit as foreign investors begin to pull out of the economy. Furthermore, nobody denies that an adjustment was necessary, I don’t believe anyone was advocating some kind of free lunch theory where Greece would have avoided recession altogether. Instead, people are worried about Greece’s long term future.

The authors continue to note:

“Unfortunately, any sign of stability has effectively been wiped away by the new Greek government. Blaming the recent capital flight from Greece and the sharp increase in government yield spreads on anything else but the election-campaign announcements and post-election decisions of Syriza would be ludicrous.”

I agree with this, and this is unfortunate.

The paper continues to comment:

” As a result, Greece enjoys quite palatable debt service requirements, with an average interest rate of 2.3% and interest payments of 4% of GDP, and the major share of interest payments is even deferred until the early 2020s”

It is true that Greece’s interest burden is much lower than many let on. This fact alone might have supported their next statement, that: ” 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.” But their ‘comfortable state’ ignores how extremely uncomfortable it is politically to have such a high level of foreign denominated debt, and how much it spooks non troika lenders, as revealed by how high they require Greek bond yields to be. Having to rely on continued bailouts from the troika is humiliating and ties their hands in terms of many policies they might want to enact. You could say it’s politically unsustainable (evidently) and It follows that debt relief might relieve these pressures a little, and might make investors a little more confident. Further, if interest burden is still so low, and Greece’s situation really is as ‘comfortable’ as the authors state, then would there really be substantial harm in allowing Greece’s primary surplus to fall a little, in order to stimulate some growth in the economy, as advocated for instance by Krugman? Again, these authors have failed to explain why this would result in a less sustainable position in the long term.

Lastly, the authors argue that while the risk of economic contagion from a Grexit is minimal, the risk of political contagion is high, with potentially disastrous consequences. This may be true, but I fail to see how this supports the notion that the path Greece & the troika took from 2010 wasn’t wrong after all; just because the political consequences of admitting this might be harmful doesn’t make this false.

In sum, meh.

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