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Monday, August 31, 2015

Thomas Philippon : "The state of the monetary union"

The state of the monetary union | VOX, CEPR’s Policy Portal

The Greek debacle

Greek people have suffered tremendously and the country is left with massive unemployment and a crushing debt overhang. As terrible as Greece’s depression might be, the right question to ask is: How much could we have avoided with better policies? The answer depends on how far back we start.
  • During the boom: reckless policies.
If we go back to the pre-crisis period, we find that most of the Greek drama would have been avoided with sensible policies. In Martin and Philippon (2014) we quantify the causes of the crises across the Eurozone and we find that Greece was (mostly) brought down by reckless government spending during the boom years. In that sense, and since Greece is a democracy, one can argue that it is first and foremost responsible for its own demise.
But we – governments, households, investors – all make mistakes, and this is why policymakers have devised mechanisms (such as debt restructuring) to deal with the consequences of these mistakes. A more directly relevant question is then: How badly was the Greek crisis handled? Or in other words, starting from 2009/2010, how much better could the Greek situation have been?
  • After 2009: only bad options.
The first thing to recognise is that, given how unbalanced the Greek economy was in 2009/2010, a major recession was inevitable. As Blanchard (2015) explains, “[h]ad Greece been left on its own, it would have been simply unable to borrow. Even if it had fully defaulted on its debt … it would have had to cut its budget deficit by 10% of GDP from one day to the next. These would have led to … much higher social cost than under the programs.”
But policy mistakes also made the situation. Some observers advocated an early debt restructuring, coupled with strong fiscal consolidation, but the perceived risk of contagion made it impossible to implement. Eventually, in 2012, Greece’s debt was reduced by approximately €100 billion. This was unfortunately too late – much of the macroeconomic damage was done.
Since an early restructuring was prevented by fears of contagion (legitimate or misguided, this is beside the point), I have argued (see Philippon 2015) that it is not fair to ask Greece to pay for the consequences of the delay. If one accepts this idea, then it follows that one should consider an alternative history – with an earlier debt restructuring – as a benchmark for Greece’s debt negotiation.
When I simulate the path of the Greek economy assuming an ‘early debt relief scenario’, I find that it is significantly better than the actual path in terms of GDP, employment, and debt dynamics. Based on these calculations, I argued that it would be fair to lower Greece’s target for primary surplus by at least 1.5%.
  • The 2015 tragedy.
The word ‘tragedy’ has been over-used to talk about Greece’s economic disaster. I do not use it to describe what happened between 2009 and 2013. Mistakes were made, but it is far from obvious that there were better alternatives available in real time.
What happened in 2015, however, does have a tragic flavour. The Greek people were led to believe that they could get a better deal if only they elected a different government. Instead, they got a worse deal, in all respects.
The first six months of the new Greek government, following the elections of January 2015, were a complete disaster.
  • In 2014, the real GDP of Greece grew for the first time since 2007, by 0.8%. Greece managed to issue bonds at 3.5%.
  • Unemployment was falling and GDP was forecast to grow by 2.5% in 2015.
  • Thanks to erratic and irresponsible policies, growth forecasts have been revised down to 0.5% and unemployment will be significantly higher than it would have been.
The tragedy comes from the clash between the economic and political dynamics described earlier.
Grexit might have made sense in 2008, but not in 2015. From 2005 to 2009, Greece accumulated a current-account deficit of 57.6% of GDP. Closing that gap required an increase in exports and a decrease in imports, which is difficult and painful to achieve without devaluation. So one could reasonably argue that an exit followed by a massive default and devaluation made sense at that time. But in 2015, the adjustment was done, painful as it was, and bygones should be bygones. A sensible policy would have been to focus on improving the economy going forward.
The 2015 elections and the ensuing negotiations, however, had nothing to do with economics. It was pure political theatre on both sides. Mr Tsipras won the elections and successfully destroyed his political opponents, inside and outside Syriza, becoming the only politician left standing and assured to head the country for at least a few more years. His tenure as prime minister has so far been a failure. On the other side, there was a clear desire in Germany to punish the new Greek government and teach a lesson to other populist movements in Europe. There are good reasons to fight populism and demagogy in Europe, but the idea that this is best done by imposing humiliating conditions in a Troika programme sounds particularly wrong-headed to me.

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