The Greek Present

Matías Vernengo

The Brazilian expression “Greek Present” (Presente de Grego) means unwelcome gift, an obvious reference to the infamous Trojan Horse.  The current crisis in Greece might show that the euro was just one of those presents.  If the European Union (EU) does not provide sufficient resources to preclude not just a default, but also and more importantly a profound recession, then the advantages of the euro for Greece and other countries in the periphery of Europe should be seriously questioned.

The Greek financial crisis is an exemplar case of the perils of macroeconomic orthodoxy, and of the exceedingly narrow measure of the changes that have taken place since the global financial crisis started.  The same conventional ideas about fiscal adjustment are repeated, no matter that their record in the past has been dismal.  The price tag of learning, once again, about the limitations of conventional wisdom is the staggering human suffering, in this case of the people in Greece, that European authorities are demanding.

In many respects the crisis seems like a conventional one, with a significant fiscal and current account deficits on the order of 13% and 12.5% of GDP respectively.  The conventional wisdom is that excessive public spending led to increasing lack of confidence and to the balance of payments problems.  As Greece cannot devalue its currency (the euro), and the possibilities for Greek workers to move to other European countries in the numbers that would be required to reduce unemployment (at around 9.8%) are limited, the only solution would be to adjust, by reducing the fiscal deficit from 13% to 3%, or default.  According to Niall Ferguson this shows that there is no Keynesian free lunch.

In line with the adjustment perspective and the pressures of the European Union and the European Central Bank (ECB), the Prime Minister George Papandreou announced severe spending cuts that will freeze salaries and cut bonuses of public workers, increase the average retirement age, and raise the burden of taxation.  Europe would grudgingly provide resources conditioned on a draconian adjustment.  As correctly pointed out by Thomas Palley: “the ECB would act as an analogue International Monetary Fund for euro member countries.”

It is important to note, however, that this is not a fiscal crisis, as conventional wisdom would have it, but an euro crisis.  If the EU had a degree of fiscal centralization compatible with the monetary union, federal transfers would cover the needs of a sub-national unit, without enforcing huge spending cuts.  That is what the federal government does (or at least tries) in the US, transferring resources to the States in a recession so that spending can be maintained.  In such a situation the risk of higher interest rates associated with the large fiscal deficits are minimal, since the Federal government that has a larger revenue base and the ability to monetize debt carries the burden of debt.  Monetization should not lead to inflation, unless the economy is at full employment.  So there is a third solution, despite Mr. Ferguson’s arguments, and that would be a Keynesian one.

In other words, the EU should issue Union debt and should transfer to Greece enough funds to deal with the crisis, large enough to completely offset the contractionary effects of the announced cuts.  The euro arrangement precludes the Keynesian solution, and essentially forces the country with a current account deficit to reduce imports, and to generate a higher export surplus to pay for the accumulated debt.  Even in a terrible recession the economy is forced to contract to reduce imports.  The euro, thus, imposes a harsh balance of payments constraint on the Greek economy.

There should be no doubt about the fundamental mistakes and the negative consequences of the pro-cyclical policies being imposed on Greece.  Argentina also faced a similar situation in the late 1990s, and fiscal adjustment was clearly incapable of reverting the crisis.  Of course Argentina was not part of a Union that could transfer resources.  But, in hindsight, devaluation and a well-managed default proved to be a better solution.  Maybe the Greeks should question how much the euro is really worth.

2 Responses to “The Greek Present”

  1. Ilene Grabel says:

    Matias raises important issues in connection with the situation in Greece. There are a couple of other issues raised by the case that are of interest to critics of neo-liberalism.

    #1. Events in Greece underscore the myriad problems associated with what has become a common and entirely wrong-headed strategy by national policymakers to tie their own hands by abandoning their national currency. There are several different mechanisms by which national policymakers in countries with relatively weak economies have instantiated this strategy: in Greece and in other countries in the eurozone it is obviously through the adoption of the euro; in the post-Communist countries on the eastern end of the European periphery policymakers are pegging their national currencies to the euro using different types of hard currency peg arrangements and/or quasi- or full currency boards (e.g., Latvia, Estonia, Lithuania and Bulgaria); and in many countries in Latin America the US dollar has been and still is used as the national currency (e.g. in El Salvador).

    Diverse economic, political and historical factors drive the decision to abandon the national currency through these arrangements, of course. But what these arrangements have in common is that they make it impossible for national policymakers to utilize currency and monetary policy as a tool of economic adjustment. This loss of policy space comes as no surprise: indeed, in the years prior to the current crisis neo-liberals praised these arrangements that tied national policymakers’ hands for precisely this reason. Since policymakers in the peripheral countries couldn’t be “trusted,” wasn’t it better to outsource currency and monetary policy to rich countries by replacing the national currency with a hard one (such as the US dollar or the Euro)? On these grounds, for instance, neoliberals celebrated Argentina’s currency board for much of the 1990s—at least, until its problems became too obvious to ignore. At that point, revisionists recast the country’s currency board as villain instead of savior.

    Critics of neo-liberalism have long warned of the problems that occur when weaker economies lash themselves to the mast of a stronger currency, such as Greece has done with the euro. Instead of being able to deploy expansionary monetary and fiscal policies and a currency devaluation in the face of the global economic crisis, the Greek government is desperate to convince investors and the European Commission that it is serious about contracting the public sector and fiscal spending. The crisis in Greece and many other countries that have tied their own hands, such as Latvia, suggest that this is a highly opportune moment to rethink policies that eliminate policymaker discretion and/or that prioritize stability for investors above all other economic goals.

    #2. Another interesting feature of the Greek situation is that the EU seems to be outdoing the IMF in terms of a rigid commitment to fiscal contraction. As the current global crisis continues to unfold, the IMF has (uncharacteristically) been loosening (though not eliminating) fiscal constraints in some of the countries where it has stand-by arrangements in place. The IMF has even allowed some program countries to raise their fiscal targets, in some case substantially, and in some cases several times (e.g. Ukraine, Hungary, Latvia, Romania). Unfortunately, this hardly means that the IMF has renounced its tendency to engineer pro-cyclical responses to crisis or that it is has done nearly enough to ease the dislocation of the crisis, especially in low-income countries. But you know that things are strange when the EU seems to be channeling the IMF circa the East Asian crisis, sternly lecturing Greece’s policymakers about the need to reign in spending, cut public sector jobs, slash wages. Maybe some of these things have needed to be done in Greece—maybe not. But a global recession surely is not the time to make radical reductions in public programs—as even the IMF is acknowledging begrudgingly in certain cases.

    #3. Finally, the Greek situation underscores the role of derivatives and currency swaps, shady accounting and predatory financial practices in the current crisis. Of course, we have already seen these things writ large in the US’ financial implosion. But I must admit that it is fascinating now to learn that the Greek national government used off balance sheet transactions, engineered by major Wall Street firms, to “cleanse” its books so as to hide vast amounts of debt from those with (what turn out to be not so) sharp pencils in Brussels (see, e.g., New York Times, 14 February 2010, p.A1, In the European context we should remember that creative accounting is not just the preserve of the Mediterranean countries of Europe—it has been long known that France and Germany massaged their budget deficits in the late 1990s.

    This matter requires further research, especially to see if other national governments used complex, opaque instruments in the same way as Greece (and Italy) apparently did, and if the credit rating agencies missed this, too, when rating Greek sovereign debt. Though the odds are not strongly in its favor these days, one hopes for serious financial regulation in response to the crisis that prevents governments from using opaque financial instruments to cook their books.

  2. Kevin P. Gallagher says:

    In addition to the points raised by Ilene above, the entire Greek discussion points to the need to reign in credit rating agencies. Remember that before Dubai there was relatively little discussion of Greece or the other “PIIGS” as they have become called. It was not until Moody’s threatened a Greek downgrade that the tailspin started. Though the US and others have a higher debt/GDP ratio than Greece ever will. The rating agencies–with just three (US) firms dominating most of world commerce, get to decide what good policy is. Scarier to me than the IMF ever was.