One could be forgiven for thinking that Greece’s official creditors have learned nothing from Greece’s disastrous economic performance over the past six years. Since, despite the central role that excessive budget policy tightening within a Euro straitjacket has played in the staggering 25% decline in the Greek economy since 2009, the official creditors are now insisting that Greece engage in further significant budget austerity within the same Euro straitjacket. This has to raise a fundamental question. Why are the official creditors thinking that the same sort of policies that led to Greece’s economic collapse and to its political radicalization over the past six years will be any more successful this time around?
At the heart of the official creditors’ economic plan for Greece is that it commit itself to generating a primary budget surplus that will allow it to begin reducing its public debt to GDP ratio from its current level of 180%. However, months of political uncertainty since Syriza’s election in January 2015 have again pushed the Greek economy into recession, which has contributed importantly to Greece’s budget swinging back into a primary deficit of around 1% of GDP. If, as reported, the creditors require Greece to generate a primary budget surplus of at least 1% of GDP in 2015 and 3% of GDP in 2016, Greece will in effect be asked to tighten its budget by around 2 percentage points of GDP a year in both 2015 and 2016.
The central characteristic of the Greek economy remains that it is stuck in a Euro straitjacket that denies it either an independent monetary or exchange rate policy that can be used to offset the contractionary effects of budget policy tightening. Based on International Monetary Fund estimates that Greece’s fiscal multipliers could be anywhere between 0.9 and 1.7, the further budget policy tightening that Greece’s official creditors are now requiring of it could constitute a headwind to economic growth of between 2 and 3 ½ percentage points in each of the next two years. With such a strong fiscal policy headwind, it is difficult to see how Greece will be able to extricate itself from economic recession over the next two years or how it will be able to start working down its very high public debt to GDP ratio.
Straightforward fiscal policy arithmetic would suggest that the official creditors’ further budget policy tightening plan has failure written all over it right from the start. Recognition of this fundamental point would suggest that the official creditors have two alternatives from which to choose if they really want the Greek economy to succeed. The first would be to accept a large scale restructuring of Greece’s official debt that would substantially reduce the size of the primary budget surplus that Greece would need to generate over the next few years to stabilize its debt ratio. The even better alternative would be for the official creditors to financially support a successful Greek exit from the Euro. Such an exit would free Greece from the Euro straitjacket that has to date prevented the use of an independent monetary and exchange rate policy as an offset to budget policy tightening. By so doing, it would at least offer the Greek economy the prospect of beginning to grow again and of being saved from a few more years of misery.
Sadly, Greece’s official creditors seem to have learned little from past experience and are showing no signs of backing off proposing more fiscal austerity for Greece. Sadder still, this means that over the next few years, the Greek economy will remain stuck in an economic depression that has already exceeded the proportions of that experienced in the United States in the 1930s.
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