Greece — a simple macroeconomic guide

Published 23rd February 2015

Simon Wren-Lewis, Professor of Economics at Oxford University, in a recent blog post, makes an important point a that I think sheds much clearer light on the debate over “austerity” and its impact in Greece.

“The deficits,” he argues,”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.” [his emphasis]

Few parties in this debate would argue with that. But framed like that you can see that the debate is not about whether austerity and unemployment could have been avoided within the context of euro membership. “The key macroeconomic question”, Wren-Lewis continues, “is how quick adjustment should be” — and he goes on to argue very convincingly that if the adjustment had been accomplished at a slower pace then the costs to Greek society in terms of lost output and skills would have been much lower.
 The argument is quoted with approval (and charts) by Professor Krugman here.

So the debate is essentially about the degree and scale of unemployment and loss of output and not the fact that it occurred.

The question that comes to my mind reading this is that if pace of the fiscal adjustment had been slower, then the deficits would have had to be higher and that would have implied that Greece would have needed additional loans from somewhere. Of course, Wren-Lewis recognizes this and says that “it would have made sense for some institution like the IMF to provide loans to the government to allow it to eliminate deficits gradually.”

But would it?

The IMF was facing immense criticism at the time for its loans to Greece — which were the largest it has ever made. Some members of the IMF argued at the time that its resources should have been used to pay for HIV medication in Africa where thousands were dying rather than a bailout of Greece, where, given the scale of the problems, the money would have almost certainly been lost. Brazil for its part abstained in 2013 when a further loan was proposed. As Peter Spiegel, journalist at the Financial Times, noted in a later article:

“Developing countries have long been uncomfortable about the outsized fund resources being devoted to the eurozone crisis, with Brazil voicing concern that an organisation aimed at helping poorer countries is being used to shore up some of the world’s largest economies.”

In the end, the IMF was only able to secure agreement for the Greek bailout to prevent a breakdown of the global financial system resulting from a disorderly Greek default and not to ease the pace of adjustment. So in the absence of a friendly lender it really is hard to say that there was any alternative to what was tabled. And what was tabled was better than nothing.

The IMF has since recognized flaws in its assumptions about the impact of austerity on Greece but that acknowledgement has merely reinforced some of its members’ view that no money should have been disbursed at all.

(Of course, for the avoidance of doubt, none of this means that Greece should run large primary surpluses now.)

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